Question

what are the links between the budget deficit and trade deficit? what would be the most effective way to reduce the trade deficit ? what is the best way to deal with our trade deficit?

Answer 1

An rise in the federal budget deficit will put upward pressure on U.S. interest rates, increasing them above similar rates overseas, both in the U.S. and overseas. This happens because the government's budget position affects the domestic saving rate. When the structural budget deficit shrinks, the government is adding homes and companies to national savings, and interest rates are falling. As the structural budget deficit increases, it reflects a claim to those savings, and interest rates have to increase to keep the market in balance. In a world in which U.S. assets are good substitutes for foreign assets, foreign investors will be tempted to buy more of the now higher yielding American assets.n a world in which U.S. assets are good substitutes for foreign assets, foreign investors will be tempted to buy more of the now higher yielding American assets.

They must first buy dollars before they can buy these assets. Thus, the foreign exchange market's net demand for money rises and the value of the dollar is said to rise. The appreciation of the dollar lowers the price of foreign goods and services in America and raises the price of American goods and services abroad. The net result is that Americans spend more on foreign goods and services, while foreigners spend less on US goods and services

Two ways to reduce the trade deficit are:

Consume less and save more- If the consumption is reduced by US homes or the government (companies save more than they spend), exports will fall and less foreign borrowing will be required to pay for consumption. This implies that consumption taxes–such as those imposed by almost all other nations in the globe–could help decrease the deficit, discourage consumption, increase savings and decrease public deficits.

Depreciate the exchange rate- Typically, trade deficit reversals are motivated by a substantial actual depreciation of the exchange rate. A weaker dollar makes imports more costly, exports less costly, and trade balance increases. Because the dollar is the reserve currency of the world and is still considered the safest currency for investors, it tends to be stronger than other currencies. But when foreign governments actively push the dollar to keep its surpluses, the US could counteract intervention by selling usd and purchasing foreign currencies

The ways to deal with the trade deficit are:

Reducing tariffs, subsidies, and other barriers facing U.S. goods in China and Europe

Unilateral measures to block imports like steel due to concerns over foreign subsidies

A weaker dollar would likely boost U.S. exports

Economic reforms in surplus nations could help