Question: Can a larger government deficit case a larger trade deficit?

Readers Question: How can a larger government fiscal deficit case a larger international trade deficit

Firstly, it is important not to confuse the two deficits.

  • Government fiscal deficit occurs when government spending is greater than tax revenues. The deficit is the annual government borrowing requirement, measured by Public Sector Net Borrowing.
  • International Trade deficit implies that the value of imports of goods is greater than value of exports. The balance of trade in goods comprises a large part of the current account. (A trade deficit may refer to trade in goods and services or just trade in goods.)

A fiscal deficit implies an injection into the circular flow. A deficit could occur due to higher government spending and/or lower taxes. This leads to an increase in consumer spending and an increase in Aggregate Demand (AD). This leads to higher economic growth and possibly inflation. With higher consumer spending, there will be an increase in imports and therefore a larger trade deficit.
ad increase - inflation

For example, lower-income tax gives consumers more disposable income so they spend more  on imported goods.

Also, the increase in AD may cause inflation; this makes UK goods relatively uncompetitive making imports more attractive. This will also contribute to a trade deficit.

Evaluation

However, a fiscal deficit doesn’t necessarily cause a trade deficit. A budget deficit could be caused by a recession and falling consumer spending. In this case, tax receipts may fall, but consumers will be buying fewer imports.

Also, if a country has export-led growth then a fiscal deficit may not lead to a trade deficit. For example, Japan and China tend to have a trade surplus whatever the state of the fiscal deficit.

UK example

UK net borrowing rises in 2010

uk-net-borrowing-budget-deficit

Current account

UK-current-account-from-2001

Initially, the current account deficit falls, but then the deficit rises.

However, there are many factors affecting the current account deficit apart from the government’s fiscal position. It is hard to make a clear correlation between the two.

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