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 3: National Accounting Perspectives

Richard A. IIey and Mervyn K. Lewis

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


INTRODUCTION This chapter, like the previous one, is concerned with the causes of the US deficit. In Chapter 1 we outlined our way of classifying the causes of the deficit in terms of four approaches (trade, absorption, savings and investment, and portfolio balance) and two perspectives for each (domestic and international). Chapter 2 looked at the trade approach. When viewing the current account deficit in these terms we found there to be certain anomalies – in particular, elasticities pessimism and the Houthakker–Magee income elasticity asymmetry – that suggest difficulties in trying to account for the deficit from the viewpoint of trade flows alone. One reason is inherent in the analysis itself. Consider the condition that a deficit ‘improving’ devaluation depends on the size of the sum of the price-elasticities of demand for exports and imports. This is an example of Marshallian partial equilibrium analysis, which requires that the market be small. Smallness in this context means that the repercussions of it on the rest of the economic system can be ignored. However, even in the relatively ‘closed’ United States, the market for all exports and imports is not a tiny part of the economy and the income and other effects on the rest of the system cannot be neglected. For such reasons, in this chapter we broaden the analysis beyond trade flows by linking up the basic accounting identities of the balance of payments statistics with the national income and production accounts in order...

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