South-Western College Publishing - Economics  
True or False - Trade Deficits are Bad
Subject Trade deficit
Topic International Trade
Key Words Exports, Imports, Balance of Payments, Current Account, Balance of Trade
News Story

The U.S. trade deficit is large and growing larger, causing concern among some economists and policy makers. The trade deficit for March was $38.2 billion, an increase of 56 percent from March 1999. The current account deficit reached $338.9 billion in 1999, 53.6 percent higher than in 1998. The question that policy makers must wrestle with is whether the trade deficit is a serious issue that needs to be addressed. Some analysts believe that the trade deficit is the single biggest threat to the current expansion of the economy. Others see the U.S. trade deficit as a source of economic stimulus to our trading partners, a safety valve for domestic inflation and the cause of an influx of foreign investment capital.

The large U.S. trade deficit is primarily the result of a booming U.S. economy and much weaker growth in Japan, Asia and the European economies. As incomes in the U.S. grow, the demand for imports increase. Imports for March were $117.4 billion, 21.9 percent higher than a year ago. In contrast, the recession in Japan and moderate growth in Europe has not produced a corresponding increase in U.S. exports.

When the value of U.S. imports exceeds exports, dollars flow out of the country. Typically this would reduce the exchange rate and add to U.S. inflation as the falling dollar makes imports more expensive. But foreign companies and investors have recycled their dollars by investing in the U.S., providing additional economic stimulus to the economy. There has been little mention of the trade deficit even among the presidential candidates. Large trade deficits tend to raise cries for protection, especially from labor unions, but a strong U.S. economy and low unemployment has silenced even this concern. What then is the issue?

The fear among policy makers is that foreign investors will pull their dollars out of the U.S. This causes the dollar to plunge and inflation to jump. At this point the Federal Reserve responds by raising interest rates sharply higher and the economic expansion is ended. There are a number of measures that could be taken to reduce the deficit. The Administration could deflate the dollar or adopt new tariffs or quotas to restrict imports. Policy makers could also slow the U.S. growth rate. Others argue that activist policies are not needed. There is some evidence that the U.S. economy is slowing and that the economies of our trading partners are improving.

(Updated July 1, 2000)

Questions
1. What is the difference between a trade deficit and a current account deficit?
2. How do imports act as a safety valve for domestic inflation?
3. Does an increasing deficit result in a loss of U.S. jobs? Explain your answer.
Source Richard W. Stevenson, "Economy May Have a Soft Spot" The New York Times, June 10, 2000.

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