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Chapter 18: Q.9 (page 451)

Under what conditions will a larger budget deficit cause a trade deficit?

Short Answer

Expert verified

Private savings are insufficient to offset spending, and private investment is not totally crowded out.

Step by step solution

01

Definition

A trade deficit occurs when the value of a country's imports exceeds the value of its exports. Both products and services are subject to imports and exports. Simply, when a country buys more goods and services than it sells, it has a trade imbalance.

02

Explanation

When private savings do not fully offset spending and private investment is not totally crowded out, a greater budget deficit will result in a rise in the trade deficit. Budget deficits lead to higher interest rates. High interest rates attracts capital inflow. As the demand for domestic currency increases, the value of the currency appreciates. This further makes exports expensive lead to a decline in export demand.

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Most popular questions from this chapter

Sketch a diagram of how sustained budget deficits cause low economic growth.

Explain why the government might prefer to provide incentives to private firms to do investment or research and development, rather than simply doing the spending itself?

What are some fiscal policies for improving the technologies that the economy will have to draw upon in the future?

Why have many education experts recently placed an emphasis on altering the incentives that U.S. schools face rather than on increasing their budgets? Without endorsing any of these proposals as especially good or bad, list some of the ways in which incentives for schools might be altered.

What must take place for the government to run deficits without any crowding out?
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