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Savings Deficits Links between the Domestic and the International Sectors Econ 102 Winter 2001 Mr. Smitka.

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Presentation on theme: "Savings Deficits Links between the Domestic and the International Sectors Econ 102 Winter 2001 Mr. Smitka."— Presentation transcript:

1 Savings Deficits Links between the Domestic and the International Sectors Econ 102 Winter 2001 Mr. Smitka

2 The 1993 Turnaround

3 Structural Balances up, too The Government is Saving

4 Interest as a share of the budget

5 Wealth & Consumption

6 Consumption is up sharply

7 Investment & Saving

8 Govt, Personal & Corp Saving

9 Domestic & Foreign Savings

10 If everyone is consuming... Then where do we get the goods? –(T-G) was negative –(S-I) is negative So C is high But I is also high AS - real GDP - can’t expand overnight –Can all of this happen simultaneously? What gives?? … inflation?

11 S-I arithmetic Y = C + I + G + X - M C = Y - T - S (“S” is private savings) (“T” taxes net of transfers) Substituting: Y = Y - T - S + I + G + X - M Rearranging: 0 = (I + G + X) - (T + S + M) –leakages equal injections Or: (T-G) + (S-I) + (M-X) = 0

12 (T-G) + (S-I) + (M-X) = 0 Govt savings (T-G) plus Private savings (S-I) plus Foreign savings (M-X) total to zero –all money goes somewhere! But these also represent the flows of real goods and services –If the government raises taxes it forces us to cut C and frees resources for G

13 Case Study: 1980s US Initial change: Reagonomics –Lower taxes –Increase G (“Star Wars”), don’t cut elsewhere –Let transfers continue their increasing trend (rising health care costs & an aging population) Despite “voodoo economics” claims during the primaries, this did increase budget deficits –the initial deficits were due to recession, not Reagan & the Democratic Congress that passed his budget –remember “structural” vs “cyclical” deficits

14 Federal Deficits & Surpluses

15 DIGRESSION Food for thought Today is different, but partly for cyclical reasons Will “W” push the “voodoo economics” against which his father campaigned in ? –Missile defense –Big tax cuts –Hands-off social security, other budget items

16 The 1993 Turnaround

17 So we borrowed a bit... Well, $5.6 trillion, mostly under Reagan and Bush Sr. So what? –Selling lots of bonds drives down prices –That’s the same as driving up interest rates Or... (the textbook’s version) –A tax cut stimulates the economy, driving up Y and hence M D and hence “r”

18 Nominal Interest Rates

19 Short-term interest rates (pink) -- as deviation from average --

20 Real Interest Rates -- deviation from trend (black line) --

21 Now what might happen? We started out the 1980s in balance (T-G) + (S-I) + (M-X) = Bit deficits (T-G) threw us out of balance ==> how adjust? Economists expected “crowding out” (T-G) + (S-I) + (M-X) = –Impossible to “buy” growth absent AS shifts –No “flex” anticipated on the intl side

22 But in fact... Real interest rates rose Attracting foreign capital And if everyone buys US$ their price rises We ended up with a very strong dollar

23 Forex Rates “real” is adjusted for movements against many currencies and for inflation rates

24 Reflecting... Large capital inflows The US went from being the world’s banker ===> To the biggest customer of the world’s banks All during a period of just 8 years

25 Capital Flows from creditor to debtor

26 Money flows … and goods? The strong dollar made imports cheap US trade moved to big deficits These deficits however let us keep growing –If used for investment, future growth will let us keep our creditors happy without tightening our belts –If used for consumption….. –Which do you think is the case? (check data!)

27 US Trade, Historically - until the 1980s - we ran trade surpluses

28 But others must adjust, too! If we “want” to run a deficit and borrow from abroad Others must “want” to run surpluses and lend overseas In fact, Japan and Germany both suffered from surplus savings –They avoided the paradox of thrift –We could have our cake (I) and eat it too (C)

29 International Savings (CA) Balances -- Europe and Japan offset the US -- Current Account Balance (Percent of GDP ) U.S Japan Germany France Italy U.K Canada k G10 average

30 Shifts in Japanese Savings Flows

31 Swings in Japan were v. large - one source of savings for the US - Investment plummeted with the transition from high growth (postwar reconstruction, convergence with the US) to “ normal ” growth c But the Japanese were still poor and kept saving So a potential “ paradox of thrift ” developed –Keynesian budget deficits bailed them out –Exports to the US bailed them out from –And a “ bubble ” during –But slow growth since then

32 So where do we get the goods?

33 Macro, not micro! As the previous chart shows, we import everything!! Aggregate trade is a “macro” issue, not a micro one Indeed, developing countries’ experience suggests protectionism exacerbates deficits Intermediate goods imports dominate, and a small “burp” in trade thus kills all production

34 Freer trade and enhanced incomes & welfare

35 Trade Rises as Share of Output

36 Freer trade leads to more trade But it also raises incomes through enhanced long-run productivity growth!! Remember, tariffs and quotas are taxes, and hurt real incomes while shifting production to sectors where we’re inefficient

37 Trade deficits Trade deficits accumulate But we’ve got lots of trade in lots of sectors There will be no sudden crisis, but: –a gradual loss in maneuvering room if we must keep real interest rates high to attract capital –lower “I” and slower long-run growth

38 Sectoral composition of trade

39 The End Economics 102 Prof. Smitka Winter 2001

40 Convergence

41 Innovations & Consumption


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