<< Chapter < Page Chapter >> Page >

Short-term movements in the business cycle and the trade balance

In the short run, trade imbalances can be affected by whether an economy is in a recession or on the upswing. A recession tends to make a trade deficit smaller, or a trade surplus larger, while a period of strong economic growth tends to make a trade deficit larger, or a trade surplus smaller.

As an example, note in [link] that the U.S. trade deficit declined by almost half from 2006 to 2009. One primary reason for this change is that during the recession, as the U.S. economy slowed down, it purchased fewer of all goods, including fewer imports from abroad. However, buying power abroad fell less, and so U.S. exports did not fall by as much.

Conversely, in the mid-2000s, when the U.S. trade deficit became very large, a contributing short-term reason is that the U.S. economy was growing. As a result, there was lots of aggressive buying in the U.S. economy, including the buying of imports. Thus, a rapidly growing domestic economy is often accompanied by a trade deficit (or a much lower trade surplus), while a slowing or recessionary domestic economy is accompanied by a trade surplus (or a much lower trade deficit).

When the trade deficit rises, it necessarily means a greater net inflow of foreign financial capital . The national saving and investment identity teaches that the rest of the economy can absorb this inflow of foreign financial capital in several different ways. For example, the additional inflow of financial capital from abroad could be offset by reduced private savings, leaving domestic investment and public saving unchanged. Alternatively, the inflow of foreign financial capital could result in higher domestic investment, leaving private and public saving unchanged. Yet another possibility is that the inflow of foreign financial capital could be absorbed by greater government borrowing, leaving domestic saving and investment unchanged. The national saving and investment identity does not specify which of these scenarios, alone or in combination, will occur—only that one of them must occur.

Key concepts and summary

The national saving and investment identity is based on the relationship that the total quantity of financial capital supplied from all sources must equal the total quantity of financial capital demanded from all sources. If S is private saving, T is taxes, G is government spending, M is imports, X is exports, and I is investment, then for an economy with a current account deficit and a budget deficit:

Supply of financial capital  =  Demand for financial capital S +  (M – X) = I +  (G – T)  
A recession tends to increase the trade balance (meaning a higher trade surplus or lower trade deficit), while economic boom will tend to decrease the trade balance (meaning a lower trade surplus or a larger trade deficit).


Imagine that the U.S. economy finds itself in the following situation: a government budget deficit of $100 billion, total domestic savings of $1,500 billion, and total domestic physical capital investment of $1,600 billion. According to the national saving and investment identity, what will be the current account balance? What will be the current account balance if investment rises by $50 billion, while the budget deficit and national savings remain the same?

Got questions? Get instant answers now!

[link] provides some hypothetical data on macroeconomic accounts for three countries represented by A, B, and C and measured in billions of currency units. In [link] , private household saving is SH, tax revenue is T, government spending is G, and investment spending is I.

Macroeconomic accounts
SH 700 500 600
T 00 500 500
G 600 350 650
I 800 400 450
  1. Calculate the trade balance and the net inflow of foreign saving for each country.
  2. State whether each one has a trade surplus or deficit (or balanced trade).
  3. State whether each is a net lender or borrower internationally and explain.

Got questions? Get instant answers now!

Imagine that the economy of Germany finds itself in the following situation: the government budget has a surplus of 1% of Germany’s GDP; private savings is 20% of GDP; and physical investment is 18% of GDP.

  1. Based on the national saving and investment identity, what is the current account balance?
  2. If the government budget surplus falls to zero, how will this affect the current account balance?

Got questions? Get instant answers now!

Questions & Answers

what is Price mechanism
Dhany Reply
introduction to economics
Uday Reply
welfare definition of economics
examine the wealth and welfare definitions of economics
What do we mean by Asian tigers
Aeesha Reply
Dm me I will tell u
What is Average revenue
How are u doing
it is so fantastic
what's a demand
Edward Reply
it is the quantity of commodities that consumers are willing and able to purchase at particular prices and at a given time
quantity of commodities dgat consumers are willing to pat at particular price
demand depends upon 2 things 1wish to buy 2 have purchasing power of that deserving commodity except any from both can't be said demand.
Demand is a various quantity of a commodities that a consumer is willing and able to buy at a particular price within a given period of time. All other things been equal.
State the law of demand
The desire to get something is called demand.
what is the use of something should pay for its opportunity foregone to indicate?
Random Reply
Why in monopoly does the firm maximize profits when its marginal revenue equals marginal cost
astrid Reply
different between economic n history
Falma Reply
If it is known that the base change of RM45 million, the statutory proposal ratio of 7 per cent, and the public cash holding ratio of 5 per cent, what is the proposed ratio of bank surplus to generate a total deposit of RM 300 million? 
Jeslyne Reply
In a single bank system, a bank can create a deposit when it receives a new deposit in cash. If a depositor puts a cash deposit of RM10,000 into the bank, assume the statutory reserve requirement is 7% and the bank adopts a surplus reserve of 8%. a. Calculate the amount of deposits made at the end o
the part of marginal revenue product curve lies in the _ stage of production is called form demand curve for variable input.
Bashir Reply
The cost associated with the inputs owned by the farmer is termed as
the cost associated with inputs owned by the farmer is termed as ____
why do we study economic
Nwobodo Reply
we study economics to know how to manage our limited resources
we study economics the know how to use our resources and where to put it
what is end
we study economics to make rational decision
we study economics only to know how to effectively and efficiently allocate our limited resource in other to meet our unlimited wants
We study economics inorder for us to know the difference of the needs and wants and aslo how to use the limited resources that are available
who is the father of economy
Yajanyi Reply
adam smith
Adam smith
professor Lionel Robins
adam smith
mariginal utility is finalized by who?
Adam Smith
Adam smith
Adam Smith
Adam smith
adam smith barter system
why we study economics
Kitojo Reply
what is equilibrium price?
This is the price In which quantity demanded is equal to the quantity supplied.
what is the principle of demand
is when the price of two item is equal
is the market price at which the demand curve and supply curve of particular commodity interest.
can we say that without macroeconomics,microeconomics can succeed? and why?
equilibrium price is when prices are equal
equilibrium price is a point at which demand and supply curve meet
please can you give us the correct answer after the lesson to be compared to our answers
Gloria Reply
in what?
why economics is the real life subject
because it is subjected to human decisions
why might an increase in money national income not necssarily lead to an increase in the standards of living
pls,who is a legal tender.can you explain well
Mary Reply
We think, that the legal tender is a form of payment of a debt or anything related, but which is not necessarily money. that can be bank notes, or coins for instance. but the bottom line is the legal tender is required to be recognized by the law, but it varies according to the jurisdiction.
Is it something like cheque
legal tender is anything that can be accepted for payment within a country
is Something legally accepted in a particular place

Get Jobilize Job Search Mobile App in your pocket Now!

Get it on Google Play

Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Principles of economics' conversation and receive update notifications?