America’s double deficit

An economy that has both a fiscal deficit and a current account deficit is usually called a “double deficit.” The United States has been in this category for many years. The opposite situation—fiscal surplus and current account surplus—is generally considered desirable, but depends heavily on the specific circumstances. China is often cited as an example of a country with long-term fiscal and current account surpluses.

Key points

  • The double deficits in the United States usually refer to fiscal deficits and current account deficits.
  • The fiscal deficit is a budget shortfall. Roughly speaking, a current account deficit means that a country sends more funds for goods and services overseas than it receives.
  • Many economists believe that double deficits are related, but there is no clear consensus on this issue.

The first twins: fiscal deficit

When a country’s expenditure exceeds its income, there will be a fiscal deficit or budget deficit. For decades, the United States has had a fiscal deficit almost every year.

Intuitively, fiscal deficits don’t sound like a good thing. But Keynesian economists believe that deficits are not necessarily harmful, and deficit spending can be a useful tool for starting a stagnant economy. When a country is experiencing economic recession, deficit spending on infrastructure and other large projects will increase aggregate demand. The workers hired for these projects spend money to promote economic development and increase corporate profits.

The government usually finances fiscal deficits by issuing bonds. Investors buying bonds are actually borrowing money from the government and earning loan interest. When the government repays the debt, the investor’s principal is returned. Providing loans to a stable government is generally regarded as a safe investment. Governments can usually be counted on to repay their debts because their taxation capabilities provide them with a reliable means of generating income.

The second twin: the current account deficit

The current account is a measure of trade and financial transactions between a country and the rest of the world. This includes the difference between the value of its exports of goods and services and the value of its imports, as well as the net amount of foreign investment and other transfer payments from abroad.

In short, a country with current account deficits spends more overseas than it absorbs. Again, intuition suggests that this is not good. These countries must continue to borrow money to fill the gap, and they must also pay interest to repay their debts. Especially for smaller developing countries, this may expose them to international investors and markets.

Persistent export and import deficits may indicate that a country has lost competitiveness, or reflect that the savings rate of people in deficit countries is unsustainably low.

Current account deficit: complicated

But like budget deficits, the truth about the current account is not that simple. In practice, current account deficits can reflect that a country is an attractive investment destination, just like the situation in the United States. Considering that developed economies such as the United States often have current account deficits, developing economies usually have surpluses.

Double deficit hypothesis

Some economists believe that huge budget deficits are related to huge current account deficits. This macroeconomic theory is called the double deficit hypothesis. The logic behind this theory is that government tax cuts will reduce income and increase deficits, and as taxpayers spend their newly earned money, they will increase consumption. Increased spending reduces the national savings rate, causing the country to increase the amount of borrowing from abroad.

When a country’s fiscal expenditure funds are used up, it usually turns to foreign investors as a source of borrowing. At the same time, the state is borrowing from abroad, and its citizens often use the borrowed money to buy imported goods. Sometimes economic data supports the double deficit hypothesis. Other times, the data is not available.

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