Global Adjustments to a Shrinking U.S. Trade Deficit

Abstract

SINCE EARLY 1985, when the U.S. administration began to encourage the depreciation of the dollar to reduce the U.S. trade imbalance, there has been considerable discussion of the need for international policy coordination to bring about a "soft landing" in the world economy. Two kinds of recessionary risks have been widely discussed. The first is that the United States will do little about its budget deficit, so that foreigners will be called on to provide significant financing for many years to come. If they become reluctant to lend, then U.S. interest rates could soar, causing the dollar to collapse, and pushing the United States into a recessionary balance-of-payments crisis. The second recessionary risk starts from an almost opposite premise: that the United States will cut its budget deficit sharply, without a compensatory fiscal expansion abroad, and thereby throw the world into an aggregate demand slump. U.S. Treasury officials in the past three years have strongly urged more expansionary fiscal policies in Germany and Japan to avoid this outcome, and influential independent economists have concurred in this advice. This paper examines the prospects for reducing the U.S. trade imbalance and the plausibility of the hard-landing scenarios. A review of evidence on the sources of the trade deficit finds that the U.S. budget deficit is the most important, but not the only major, source. Reducing the budget deficit would help to reduce the trade deficit, but even if the This paper has benefited substantially from a collaborative research effort on simulation modeling of international macroeconomic interdependence with Warwick McKibbin of the Reserve Bank of Australia. The global simulation project is supported by grants from the World Institute of Development Economics Research (WIDER), in Helsinki, Finland, and from the Brookings Institution.

Importing Equality? The Impact of Globalization on Gender Discrimination

“…In the trade literature, some evidence supports the idea that the increase in competition from trade is exogenous to the gender wage gap in an industry; for example, Sachs (1988) suggested that the trade experience in the 1980s was in large part due to the effects of monetary and fiscal policy on the exchange rate. Alternatively, one can directly test the validity of the exogeneity assumption by examining the data itself: if the assumption fails to hold, one would expect industries with a higher gender wage gap at the beginning of the period to be more vulnerable to trade, all else equal.…”

The U.S. Current Account and the Dollar

“…These issues were discussed at length in the Brookings Papers then. (For example Cooper [1986], Baldwin and Krugman [1987], Dornbusch [1987], Sachs and Lawrence [1988], with post-mortems by Lawrence [1990] and Krugman [1991].) Another much discussed issue was the respective roles of deficit reduction and exchange rate adjustment.…”

“…Many of the discussions at Brookings in the late 1980s were about the respective roles of budget deficit reduction and exchange rate adjustment. To take two examples: Sachs [1988] argued "the budget deficit is the most important source of the trade deficit. Reducing the budget deficit would help reduce the trade deficit [ while] an attempt to reduce the trade deficit by a depreciating exchange rate induced by easier monetary policy would produce inflation with little benefit on the current account", a view consistent with the third scenario above.…”

Thrift as a Trade Problem: The External Surpluses of Japan

“…The growing foreign demand for Japanese output, which is suggested in the figure by the rising current account surplus, clearly promoted fiscal retrenchment. The declining overall financing needs (inclusive of public investment spending) of the Japanese authorities helped to ensure a redirection of saving flows towards the requirements of the US budget (Sachs, 1988).…”