Fiscal Deficit and Trade Surplus

Readers Question:  How can a smaller government fiscal deficit cause a larger international trade surplus?

  • A smaller fiscal deficit means the government is reducing its borrowing. Therefore tax revenues must be increasing faster than government spending.
  • A trade surplus means that the value of exports is greater than the value of imports.
  • Suppose the government reduce the fiscal deficit by increasing income tax. This has the effect of reducing consumers’ disposable income and therefore will cause lower spending. This will lead to lower spending on imports, leading to an improvement in the trade surplus. This would especially be the case in the examples of UK and US, because they tend to have a high marginal propensity to import.
  • If you look at US current account, you can see the deficit reduces in periods of slower economic growth
  • Another issue is that if the government reduce fiscal deficit they are effectively pursuing deflationary fiscal policy – higher taxes lower spending. This should reduce inflationary pressure and therefore could make UK exports more competitive.

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