Untangling the US Deficit

Untangling the US Deficit

Evaluating Causes, Cures and Global Imbalances

Richard A. IIey and Mervyn K. Lewis

As the US current account deficit has expanded to a record level of $811 billion in 2006, debate about the deficit’s causes and consequences has also grown. Is the deficit a product of American profligacy or a ‘glut of savings’ in the rest of the world? Is it a serious problem or essentially benign? Untangling the US Deficit charts a course between the competing explanations in a systematic and rigorous approach, incorporating the latest academic research and market data. Particular attention is given to the China–United States trade imbalance and to the special role of the US dollar and US capital markets in global finance.

Chapter 2: The Trade Perspective

Richard A. IIey and Mervyn K. Lewis

Subjects: economics and finance, financial economics and regulation, money and banking


TWO APPROACHES This chapter and the next examine the causes of the US current account deficit (or, if preferred, the US capital account surplus). There is no shortage of hypotheses put forward to account for this phenomenon which, from the perspective of the United States at $811 billion in 2006, is at an historically unprecedented high and, from the viewpoint of the international economy, absorbs perhaps as much as four-fifths of cross-border world savings flows. Our analysis seeks to untangle the various explanations that have been offered and analyse them in a systematic manner. As noted in the previous chapter, there are two broad ways to approach a country’s current account position. One is in terms of the imports and exports of goods and services (along with other current transfers and income flows) and the associated financing implications in terms of capital flows. The other starts with the national income and production accounts to show how an imbalance between total domestic demand for goods and services and domestic production or, equivalently, between domestic investment and domestic savings, gives rise to net imports or net exports of goods and services to fill the gap. The first tends to look more narrowly, although not exclusively, upon trade flows and the financial aspects of capital inflows and outflows, whereas the second introduces a wider range of factors both within and across countries. The trade flow perspective is the topic of this chapter. Chapter 3 considers the national income...

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