Fiscal Policy and the Trade Balance

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Copyright  2011 Pearson Canada Inc. 23 - 1 Chapter 23 Monetary and Fiscal Policy in the ISLM Model Copyright  2011 Pearson Canada Inc. 23 - 2 Factors that Shift the IS Curve • A change in autonomous factors that is unrelated to the interest rate – Changes in autonomous consumer expenditure – Changes in planned investment spending unrelated to the interest rate – Changes in government spending – Changes in taxes – Changes in net exports unrelated to the interest rate Copyright  2011 Pearson Canada Inc. 23 - 3 Shifts in the IS Curve Copyright  2011 Pearson Canada Inc. 23 - 4 Factors that Shift the LM Curve • Changes in the money supply • Autonomous changes in money demand Copyright  2011 Pearson Canada Inc. 23 - 5 Shift in the LM Curve from an Increase in the Money Supply Copyright  2011 Pearson Canada Inc. 23 - 6 Shift in the LM Curve from a Decrease in the Money Supply Copyright  2011 Pearson Canada Inc. 23 - 7 Response to a Change in Monetary Policy • An increase in the money supply creates an excess supply of money • The interest rate declines • Investment spending and net exports rise • Aggregate demand rises • Aggregate output rises • The excess supply of money is eliminated • Aggregate output is positively related to the money supply Copyright  2011 Pearson Canada Inc. 23 - 8 Response of Aggregate Output and Interest Rate to an Increase in the Money Supply Copyright  2011 Pearson Canada Inc. 23 - 9 Response to a Change in Fiscal Policy I • An increase in government spending raises aggregate demand directly; a decrease in taxes makes more income available for spending • The increase in aggregate demand cause aggregate output to rise • A higher level of aggregate output increases the demand for money Copyright  2011 Pearson Canada Inc. 23 - 10 Response to a Change in Fiscal Policy II • The excess demand for money pushes the interest rate higher • The rise in the interest rate eliminates the excess demand for money • Aggregate output and the interest rate are positively related to government spending and negatively related to taxes [...]... mix The Policy Mix and German Unification Monetary versus Fiscal Policy • Complete crowding out – Expansionary fiscal policy does not lead to a rise in output – Increased government spending increases the interest rate and crowds out investment spending and net exports • The less interest-sensitive money demand is, the more effective monetary policy is relative to fiscal policy Effectiveness of Monetary. .. and Interest Rate to Expansionary Fiscal Policy Effects from Factors That Shift the IS and LM Curves Fiscal Policy and the Trade Balance Fiscal Policy and the Trade Balance By: OpenStaxCollege Government budget balances can affect the trade balance As The Keynesian Perspective chapter discusses, a net inflow of foreign financial investment always accompanies a trade deficit, while a net outflow of financial investment always accompanies a trade surplus One way to understand the connection from budget deficits to trade deficits is that when government creates a budget deficit with some combination of tax cuts or spending increases, it will increase aggregate demand in the economy, and some of that increase in aggregate demand will result in a higher level of imports A higher level of imports, with exports remaining fixed, will cause a larger trade deficit That means foreigners’ holdings of dollars increase as Americans purchase more imported goods Foreigners use those dollars to invest in the United States, which leads to an inflow of foreign investment One possible source of funding our budget deficit is foreigners buying Treasury securities that are sold by the U.S government So a budget deficit is often accompanied by a trade deficit Twin Deficits? In the mid-1980s, it was common to hear economists and even newspaper articles refer to the twin deficits, as the budget deficit and trade deficit both grew substantially [link] shows the pattern The federal budget deficit went from 2.6% of GDP in 1981 to 5.1% of GDP in 1985—a drop of 2.5% of GDP Over that time, the trade deficit moved from 0.5% in 1981 to 2.9% in 1985—a drop of 2.4% of GDP In the mid-1980s, the considerable increase in government borrowing was matched by an inflow of foreign investment capital, so the government budget deficit and the trade deficit moved together 1/8 Fiscal Policy and the Trade Balance U.S Budget Deficits and Trade Deficits In the 1980s, the budget deficit and the trade deficit declined at the same time However, since then, the deficits have stopped being twins The trade deficit grew smaller in the early 1990s as the budget deficit increased, and then the trade deficit grew larger in the late 1990s as the budget deficit turned into a surplus In the first half of the 2000s, both budget and trade deficits increased But in 2009, the trade deficit declined as the budget deficit increased Of course, no one should expect the budget deficit and trade deficit to move in lockstep, because the other parts of the national saving and investment identity—investment and private savings—will often change as well In the late 1990s, for example, the government budget balance turned from deficit to surplus, but the trade deficit remained large and growing During this time, the inflow of foreign financial investment was supporting a surge of physical capital investment by U.S firms In the first half of the 2000s, the budget and trade deficits again increased together, but in 2009, the budget deficit increased while the trade deficit declined The budget deficit and the trade deficits are related to each other, but they are more like cousins than twins Budget Deficits and Exchange Rates Exchange rates can also help to explain why budget deficits are linked to trade deficits [link] shows a situation using the exchange rate for the U.S dollar, measured in euros At the original equilibrium (E0), where the demand for U.S dollars (D0) intersects with the supply of U.S dollars (S0) on the foreign exchange market, the exchange rate is 0.9 euros per U.S dollar and the equilibrium quantity traded in the market is $100 billion per day (which was roughly the quantity of dollar–euro trading in exchange rate markets in the mid-2000s) Then the U.S budget deficit rises and foreign financial investment provides the source of funds for that budget deficit 2/8 Fiscal Policy and the Trade Balance International financial investors, as a group, will demand more U.S dollars on foreign exchange markets to purchase the U.S government bonds, and they will supply fewer of the U.S dollars that they already hold in these markets Demand for U.S dollars on the foreign exchange market shifts from D0 to D1 and the supply of U.S dollars falls from S0 to S1 At the new equilibrium (E1), the exchange rate has appreciated to 1.05 euros per dollar while, in this example, the quantity of dollars traded remains the same Budget Deficits and Exchange Rates Imagine that the U.S government increases its borrowing and the funds come from European financial investors To purchase U.S government bonds, those European investors will need to demand more U.S dollars on foreign exchange markets, causing the demand for U.S dollars to shift to the right from D0 to D1 European financial investors as a group will also be less likely to supply U.S dollars to the foreign exchange markets, causing the supply of U.S dollars to shift from S0 to S1 The equilibrium exchange rate strengthens from 0.9 euro/ dollar at E0 to 1.05 euros/dollar at E1 A stronger exchange rate, of course, makes it more difficult for ...The Effects of Devaluation on the Trade Balance and the Balance of Payments: Some New Results Marc A. Miles R~itgti, Colltgr, Rntg<r\-Thr Stnte Lrl?r'er\rt\ This paper examines the statistical relationship between de\raluation ant1 both the trade balance and the balance of paymelits for 16 de\raluatio~lsof 14 countries in the 1960s. Using several tests involv- ing both the seemingly u~lrelated and pooled cross-section time- series regression techniques, the paper tests the effect of devaluation hile sta~~dardizirlg for other variables that map affect the foreign accounts. \Yhile the balance of pa)-merits does seem to improve follo\ving devaluation, no evidence is found to support the hypothe- sis that cievaluation improves the trade balance. The paper con- cludes that the acljustment to devaluation is essentially monetary in nature, involving only a portfolio stock adjust~nent. Within the international trade literature, it is not uncommon to find arguments about lvhether devaluation will improve the trade balance or the balance of payments. Each theoretical approach has its own set of arguments. For example, the proponents of the elasticities ap- proach (e.g., Robinson 1947; Metzler 1948) describe the necessary and sufficient conditions for an improvement in the trade balance in terms of elasticities of demand and supply. If the demand elasticities are sufficiently large and the supply elasticities sufficiently small, devaluation should improve the trade balance. Proponents of the absorption approach (e.g., Alexander 1952; Johiison 1967) describe 11on. devaluation nlay change the terms of trade, increase production, l'he author ~vould like to thank Jacob Frenkel, Harr! Johnson, Arthur Laffer, Stephen Slagee, John Bilson. and an anonvmous referee for helpful aclvice and corn- ments. The\- should not be held responsible. holve~er, for any remaining errors. [Joiir~i(il 01 PoJ~IIc(I/ F~orzo~riv, 1979. xol. Xi, no 11 'G 1979 by 1 he Yni\ersii\ of C:hicago. 0022-380817Y~8703-00Oti$01 58 THE ETFECTS OF DEVAI L ATION 60 1 switch expenditure from foreign to domestic goods, or have some other effect in reducing domestic absorption relative to production and thus improving the trade balance. International niorletarists (e.g., Mundell 197 1 ; Dornbusch 1973n; Frenkel and Rodriguez 1975) argue that derraluation reduces the real value of cash balaiices andlor changes the relative price of traded and nontraded goods, thus im- proving both the trade balance and the balance of payments. This article, however, examines the statistical relationship between devaluation and the two foreign accounts. More specifically, the arti- cle tries to determine if, on the average, devaluation improves the trade balance andior the balance of payments. No attempt is niade to show the merits of one theoretical approach over another. While the theoretical discussion is primarily in terms of a monetarist model, the final empirical 111odel is a reduced-form equation that is not inconsis- tent u.ith the other theoretical models. If devaluation causes a significant improvement in the trade balance, this irnprovernent should he statistically observable regardless of ivhich theoretical ap- proach is used. Section I describes empirical studies of the effects of devaluation by other authors and analyzes why their approaches fail to answer the relevant questions completely. Section I1 describes the functional forms used in this study and summarizes the theory behilid the model. Section I11 describes the various tests and their results. Finally. Section IV summarizes the results and drarvs some conclusions. I. Other Empirical Studies In recent years several papers have appeared tvhich have tried to analyze empirically the effect of devaluation on the trade balance and balance of payments. There are three basic objectio~is that one can niake DEVALUATION AND THE TRADE BALANCE: A NOTE ALBERT 0. HIRSCHM/IAN I N SPITE of extensive literature on the 1 subject, one point in the formal theory of foreign exchanges still needs clarification: the effect of devaluation on the trade (or current account) balance when total imports (current payments) are not equal to total ex- ports (current receipts). AIarshall was first to point out that devalua- tion nliqht produce an unfavorable effect on a balance of trade in equilibrizun on the condition that "the total elasticity of demand of each country be less than unity, and on the average be less than one half. . . ." He added that "nothing approaching this has ever occurred in the real world: it is not inconceivable, but it is absolutely impossible." Lerner has re- stated this theorem in his Econo?nics of Con- trol. The theory was considerably amplified by A. J. Brown who added the elasticities of sup- ply, the marginal propensities to import, and several other factors to the demand elasticities as determinants of the trade balance upon devaluation. * The starting point of Brown's investigations remained, however, a trade bal- ance in equilibrium. This assumption was discarded by Joan Robinson who derived the correct formula for the effect of devaluation on a trade balance which is not in equilibrium, but only for the case of the balance expressed in domestic cur- rency: she ignored the fact that a different expression obtains for the usually more im- portant balance in terms of foreign currency. 'The author is an economist with the Board of Gover- nors of the Federal Reserve System; the views expressed in this note are not necessarily those of the Board. Thanks arc expressed to Alesander Gersch~nkron and George Jaszi for thoroush discussion and criticism. '.41fred hfarshall, Money, Credit, and Commerce (London, 1923)~ -kppendix J, p. 354. 3Ne~ 1944, p. 378. I'ork, 'A. J. Brown, "Trade Balances and Exchanre Stability," Oxfovd Econor~tic Papers, VI (April 19421, pp. 57-75. Cf. also J. J. Polak, "Exchange Depreciation and International Monetary Stability," this REVIEW, XXIX (1947). p. 178, for an adaptation of Brown's formula. Joan Robinson, Essays in the Theory of Employment (Osford, 1917, 2nd Edition), pp. 142, 143. Since attention will be focused here on the effect of devaluation for varying positions of the trade balance, the following analysis will be made only in terms of demand elasticities. To the reader of Brown and Robinson this will mean that the elasticities of supply are assumed to be infinite, i.e., that exports and imports are supplied at constant costs within the rele- vant range. This, however, need not be the case if the analysis is made in terms of elas- ticities of demand for foreign exchange rather than for the ZIO~~~VZ~ imports from abroad. OF -4 short digression may be in order to explain this distinction. The study of the effect of devaluation on the trade balance can start by considering the demand and supply curves for foreign exchange which have been made familiar by the writings of Bresciani-Turroni, Viner, and hlachlup. These curves result from a transposition of 3Iarshall's curves for E- and G-bales, so as to make the ordinate represent the ratio of interchange between E- and G-bales and the abscissa either E- or G-bales. From here it seems quite natural to pass to the foreign exchange diagram in which the abscissa repre- sents quantities of foreign (domestic) currency, while the ordinate denotes the rate of exchange expressing the number of units of domestic (foreign) currency that have to be yielded to acquire one unit of foreign (domestic) cur- rency. Great care must be exercised, however, in making Chapter 22 Aggregate demand, fiscal policy, and foreign trade David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith 22.1 Some key terms  Fiscal policy – the government’s decisions about spending and taxes  Stabilization policy – government actions to try to keep output close to its potential level  Budget deficit – the excess of government outlays over government receipts  National debt – the stock of outstanding government debt 22.2 Government in the income-expenditure model  Direct taxes – affect the slope of the consumption function – and hence the slope of the AD schedule.  Government expenditure affects the position of the AD schedule 22.3 Fiscal policy? Income, output 45 o line AD 0 Y 0 But this ignores some important issues – prices, interest rates, and the need to fund the government spending. AD 1 This seems to suggest that the government could influence aggregate output in the economy by raising AD from AD 0 to AD 1 , Y 1 thus raising equilibrium output from Y 0 to Y 1 . 22.4 but in surplus at high levels then the budget will be in deficit at low levels of income The government budget The budget deficit equals total government spending minus total tax revenue. If government spending is independent of income G Income, output but net taxes depend on income, The balanced budget multiplier states that an increase in government spending plus an equal increase in taxes leads to higher equilibrium output. Balanced budget 22.5 Deficits and the fiscal stance  The size of the budget deficit is not a good measure of the government’s fiscal stance.  The structural budget shows what the budget would have been if output had been at the full-employment level.  The inflation-adjusted budget uses real not nominal interest rates to calculate government spending on debt interest. 22.6 Automatic stabilizers  mechanisms in the economy that reduce the response of GNP to shocks – for example, in a recession: – payments of unemployment benefits rise – and receipts from VAT and income tax fall 22.7 Limits on active fiscal policy  Time lags: it takes time – to diagnose the problem – to take action – for the multiplier process to operate  Uncertainty – the size of the multiplier is not known – aggregate demand is always changing  Induced effects on autonomous demand – changes in fiscal policy may induce offsetting effects in other components of aggregate demand Why can’t shocks to aggregate demand immediately be offset by fiscal policy? 22.8 Limits on active fiscal policy (2)  The budget deficit – concern about inflation if the budget deficit grows  Maybe we’re at full employment! – unemployment may be (at least partly) voluntary Why doesn’t the government expand fiscal policy when unemployment is persistently high? 22.9 Foreign trade and income determination  Introducing exports (X) & imports (Z)  TRADE BALANCE – the value of net exports (X - Z)  TRADE DEFICIT – when imports exceed exports  TRADE SURPLUS – when exports exceed imports  Equilibrium is now where – Y = C + I + G + X - Z [...]...Exports, imports and the trade balance Assume that exports are independent of income, but that imports increase with income Imports Exports Y* Income At relatively low income, exports exceed imports – there is a trade surplus At higher income levels, there is a trade deficit There is trade balance at income Y*, but there is no guarantee that this corresponds to full employment 22.10 Foreign trade and the multiplier... goodEvidence for interactions between domains of TatA and TatB from mutagenesis of the TatABC subunits of the twin-arginine translocase Claire M. L. Barrett and Colin Robinson Department of Biological Sciences, University of Warwick, Coventry, UK The twin-arginine translocation (Tat) system operates in the plasma membranes of a wide range of bacteria as well as the thylakoid membrane in plant chloro- plasts (reviewed in [1,2]). Working in parallel with the Sec system, it is responsible for the export of a subset of proteins into the periplasm, outer membrane or extracellular medium, and the primary defining attrib- ute of the system is its ability to transport proteins in a fully folded state [3,4]. Particular attention has centred on a series of periplasmic proteins that are exported only after binding redox cofactors such as FeS or molybdopterin centres [5–8] although it should also be emphasized that the system also transports proteins that do not bind cofactors [1,2]. Substrates for the Tat pathway are exported post- translationally [8] after synthesis with cleavable, N-ter- minal signal peptides that almost invariably contain an essential twin-arginine motif in the N-terminal domain [9,10]. They then interact with a translocon in the inner membrane that consists, minimally, of three sub- units (TatABC) in Escherichia coli and several other Gram-negative bacteria studied to date. Genetic stud- ies indicate that the tatABC genes are all important for Tat activity although a fourth gene, tatE, encodes Keywords green fluorescent protein (GFP); Tat system; twin-arginine; protein transport; signal peptide Correspondence C. Robinson, Department of Biological Sciences, University of Warwick, Coventry, CV4 7AL, UK Fax: +44 2476523701 Tel: +44 2476523557 E-mail: Crobinson@bio.warwick.ac.uk (Received 13 December 2004, revised 25 February 2005, accepted 8 March 2005) doi:10.1111/j.1742-4658.2005.04654.x The twin-arginine translocation (Tat) system transports folded proteins across the bacterial plasma membrane. Three subunits, TatA, B and C, are known to be involved but their modes of action are poorly understood, as are the inter-subunit interactions occurring within Tat complexes. We have generated mutations in the single transmembrane (TM) spans of TatA and TatB, with the aim of generating structural distortions. We show that sub- stitution in TatB of three residues by glycine, or a single residue by proline, has no detectable effect on translocation, whereas the presence of three gly- cines in the TatA TM span completely blocks Tat translocation activity. The results show that the integrity of the TatA TM span is vital for Tat activity, whereas that of TatB can accommodate large-scale distortions. Near-complete restoration of activity in TatA mutants is achieved by the simultaneous presence of a V12P mutation in the TatB TM span, strongly implying a direct functional interaction between the TatA ⁄ B TM spans. We also analyzed the predicted amphipathic regions in TatA and TatB and again find evidence of direct interaction; benign mutations in either subunit completely blocked translocation of two Tat substrates when present in combination. Finally, we have re-examined the effects of previously ana- lyzed TatABC mutations under conditions of high translocation activity. Among numerous TatA or TatB mutations tested, TatA F39A The Difference between Level of Trade and the Trade Balance The Difference between Level of Trade and the .. .Fiscal Policy and the Trade Balance U.S Budget Deficits and Trade Deficits In the 1980s, the budget deficit and the trade deficit declined at the same time However, since then, the deficits... first half of the 2000s, the budget and trade deficits again increased together, but in 2009, the budget deficit increased while the trade deficit declined The budget deficit and the trade deficits... twins The trade deficit grew smaller in the early 1990s as the budget deficit increased, and then the trade deficit grew larger in the late 1990s as the budget deficit turned into a surplus In the