While organizing my digital files, I came across a college Economics assignment I completed around 2005. I believe the elements contained are every bit as appropriate today as they were then – you might say, even more so.
Here’s a short excerpt. I welcome any and all opinions. (If you want me to stop posting all this long-haired, intellectual horse shit on the Board, let me know!)
1) Any excess of national spending over income must be financed by foreigners. The current account deficit is equivalent to the net inflow of capital from abroad. The following adjustments to the economy could be made to reduce the deficit:
Increase taxes, without increasing government spending
· This would reduce the government budget deficit (T-G) and reduce the amount that must be borrowed to finance the deficit
· This could have the effect of slowing down the economy
Reducing the level of government spending
· This has the same effect of increasing taxes
The view that the current account deficit arises from the widening U.S. budget deficit has received considerable attention of late, and is reminiscent of the mid 1980’s “twin deficit”. Some economists believe that a larger fiscal deficit boosts domestic demand, causing domestic interests rates to rise relative to foreign rates; this, consequently, attracts investors and increases the value of the dollar, in turn, leading to a larger current account deficit.
2) Sustained budget deficits demonstrate the negative effects of deficits on long-term economic growth. A conventional view would hold that ongoing budget deficits cause a decrease in national saving, which reduces domestic investment and increases borrowing from abroad. Interest rates play a major role in how the economy adjusts. The reduction in national saving causes domestic interest rates to rise, which dampens investment and attracts capital from abroad. Substantial deficits projected far into the future can very possibly cause a fundamental shift in market expectations, and a related loss of confidence both at home and abroad. The fiscal and current account imbalances may also cause participants in foreign exchange markets to lose confidence in the markets, as they become increasingly alarmed by the prospect of ongoing budget deficit and the related current account deficit. The loss of both creditor and investor confidence, again, both at home and abroad will, most obviously, cause creditors and investors to reallocate funds away from dollar-based investments. This in affect causing a depreciation of the U.S. dollar exchange rate.
3) Deficits that are small and transitory may not pose calamitous repercussions; however, an environment in which deficits are large and permanent promotes a climate that may severely affect expectations and confidence. Furthermore, this may generate a self-reinforcing negative cycle that serves to underscore fiscal deficit, financial markets and the real economy.
