Crowding out (Economics) ; International trade ; Budget deficits ; Balance of payments

Charles Pigott

Michael Hutchison

English

Research Papers in Economics

IF~(dl~JYC1\\ll IR2.~~~IfW~
IaC1\\1ffiIk;, (G) ~
~@1ffi IFIf@\lffi(C 11 ~)<C(\Jl
January 27,1984
------------
Export Crowding Out
The US economic recovery continues
at abriskpace, with real GNPrising in 1983
by over 6 percent. Although the overall
strength ofthe economy at this stage is
fairly typical ofearlier post-World War II
expansions, the composition ofoutput is
substantially different. Namely, the export
sector is far weaker in this recovery than
in previous upswings. The U.S. current
accountdeficiton international payments
(goods, services and transfers) reached
nearly $40 bil-lion in 1983-the largest on
record. This year's deficitwill probably be
larger, with forecasts ranging from $40 to
$80 billion. This Letter identifies reasons
for the deterioration in the U.S. export and
importsectors, and explores the link
between the resulting current account
deficitand the massive creditdemands
posed by current and projected federal
government budget deficits.
Cyclical weakness
Some weakness in the international trade
sector usually develops duringa business
cycle upturn. The chart shows the trough of
the downturn (marked on the timeline as
"0"), three quarters preceding the trough
and eight quarters followingthe trough, for
the average current accountbalance from
six previous business cycles and the cur-
rent accountbalance in the present cycle.
The diagram shows that a cyclical deteri-
oration in the current account has been a
normal developmentduring economic
recoveries in the post-war period. An
upswing causes domestic income to grow
faster than incomes abroad, spurring a
greater demand for imports; the trade and
current account balances consequently
decline. It is primarily the pattern of
demand in the U.S. and abroad, therefore,
that causes the cyclical weakness in the
"external" sector. The downturn in net
exports usually runs its course after a per-
iod ofseveral quarters and then stabilizes.
Current account deficits in the present
recovery exceed the typical cyclical
deterioration duringa business upswing.
While it is true that the.U.S, recovery is
leading that ofthe other major western
industrial countries (excepting Canada) to
an extent greaterthan usual, this alone
does not explain the unprecedented
deficits. The drop in the current account
balance as a percent ofGNP is almost
twice as large as the average post-war
decline, and it surpasses the decline in any
individual previous cyclical upturn. In addi-
tion, the absolute size ofthe present
current account deficit (in both dollar
amount and as a percentofGNP) sur-
passes that ofany previous post-war
period, duringa business cycle upswing or
otherwise. Forecasts suggest that deficits
through 1984 could stabilize at an unprec-
edented 1.5 percent ofGNP ormore, rather
than at the rough balance which has been
typical in the second year ofmost eco-
nomic recoveries.
Strongdollar, weakexports
Thus, a large part ofthe current account
deficit is related to non-cyclical factors, the
most significant ofwhich is the high real
(price adjusted) value ofthe dollar in
exchange markets. The dollar is currently
more than 30 percent higheron atrade
weighted basis, in both nominal and real
terms, than it was in 1980. Dollarappre-
ciation has raised dramatically the prices of
u.s. goods in comparison to those ofour
foreign competitors. As a result, U.s.
exporters have found it increasingly difficult
to sell abroad, and U.s. producers at home
have found it more difficultto compete with
foreign imports. The current account bal-
ance therefore has deteriorated because
our imports of goods and services have
grown considerably faster than ourexports
(more than twice as fast between 1980
and 1982).IF(~: ((11 (~IT'Ct1\ll IR~~ §(~lfW~
15)/:)\IT\.\Ik: (\) \1
§ '"'c,' f" rc; ~'''''\ '1\' 'C' 11 (C' fC: (\J\ "'~ l<;,1J )\ !J II (i;\" L\ L\ ~,,' '", \,;,) ~", "j
()pinions expressed in thi.t;:. news!ptlPf do not
neccssarilv rf,:f1ect the vic\vs of thi.' rnanagernf::'l1t
o( II'H' Federal Re'serve Bank of .San Frar1c'i:;co,
or of the Board o( CovC'fnors of lht' Federal
Reserve Svstern.
Why has the dollar remained so high in
recent years? The answer lies largely with
U.s, monetary and fiscal policies and their
impacton credit markets, Beginning in
1979, the Federal Reserve slowed money
growth to reduce inflation, For several
years, money increased moreslowly than
prices, resulting in a progressive tightening
ofreal liquidity that pushed upour real
(inflation-adjusted) interest rates; this
increase in real interest rates in turn raised
the value ofthe dollaron the foreign
exchanges, By mid-1982, however, the
upward pull ofmonetary policy on interest
rates and the dollar began to wane. As
inflation fell sharply and moneygrowth
accelerated, real liquidity began to
increase, At this point, however, growing
federal governmentbudget deficits (a $138
billion increase in fiscal 1983 overthe 1981
level) added to private creditdemands and
prevented the fall in our real interest rates
that would otherwise have occurred,
This explanation suggests thatthere is a
basic economic linkbetween government
budgetdeficits and current account defi-
cits. Considerthe economydivided into
three sectors: the government sector, the
domestic private sector and the inter-
national sector, All together, the total
supply ofcredit must balance the total
demand for credit. When the government
sector runs a net deficit, ithas a net
demand for creditthat must be met by
some combination ofcredit supplied from
the domestic private sector (i.e" an excess
ofprivate domestic saving over invest-
ment) and the international sector. The
latter source ofcredit results from a current
account deficit. Because the present
current account deficitrepresents the
excess ofu.s. purchases over sales of
goods to foreigners, it reflects an extension
offoreign creditto the U.s. and hence a net
capital inflowintothe U.s.economy; that is,
foreign resources are being transferred to
the U.S. to complement domestic produc-
tion in meeting the growing government
demand for goods and services,
2
Since supply-sider hopes for a large jump in
private domestic savings to augment credit
supplies have yetto be realized, rising
federal government budget deficits are to
some extent being financed by foreign
creditors via the U,S. current account
deficit. They do so directly when they
purchase U.S, government securities, and
indirectly by lending to private U.s, entities.
In a closed economy, without an external
sector, increased government spending
competeswith privatespendingand tosome
extent"crowdsout" domestic consumption
and, especially, domestic investment. In an
open economy such as that ofthe U.s., gov-
ernment spending will also crowd out
resources destined forthe export and
import-competing sectors.
Outlook
Since federal deficits in 1984 will probably
growdespite the cyclical expansion, large
governmentcreditdemands (in the absence
of a substantial increase in net savings from
the private sector) will likely keep real
interest rates and the dollar at high levels.
This will generate continued large foreign
capital inflowsand current accountdeficits.
It appears, therefore, that the export- and
import-competing sectors will continue to
remain weak spots in an otherwise robust
economic recovery,
The longer-term outlook for the interna-
tional sectoris less clear, however, assuming
that large budget deficits persist. Oneview
is that large current account deficits are not
sustainable for an extended period because
foreigners are notwilling to increase their
U.S, claims indefinitely, This implies that
the real valueofthe dollarmust eventually
declineto bringthecurrentaccountbalance
backto amoresustainable level. The upshot
ofthis argument is thata large part ofper-
sistent government budget deficits cannot
continually be financed from abroad, and
wiII eventually crowd out domestic spend-
ing ina way analogous to the closed econ-
omycase. In this circumstance, U.S, interest
rates would remain both stubbornly highDoes this implythat the dollar's value can
be expected to fall back to its pre-1980 real
level with stable or somewhat lower real
interest rates in the U.5. compared to those
abroad? Not necessarily. Proponents ofthe
second argument pointout that the dollar's
value is notonlydetermined by relative
interest rates in financial markets. Over the
longerterm, thereal valueofthedollarmust
also be consistent with the supply and
demand for goods in the economy. In par-
ticular, a strong dollarmay well be nec-
essary to keep the current account in deficit
-toeffectthetransferofreal resources from
abroad to the U.5. that is needed to finance
our budgetdeficit. For this reason, asig-
nificant part ofthe dramatic rise in the value
ofthe dollarsince mid-1980 may be main-
tained, even in the face ofmoderate interest
rate declines, for the foreseeable future. In
essence, this view suggests that wemay be
witnessing a permanent upward shift in the
value ofthe dollar-a shift caused by the
new stance offiscal policy in the United
States. This shiftcan be thoughtofas reflect-
ing the fact that fewer U.5. goods will be
available to foreigners in the future since
more will be absorbed domestically be-
cause ofourfiscal deficits..
In short, both views pointto substantial
crowding outofthe private sector ifbudget
deficits persist. They differ in the industries
that will suffer the most. The first view
suggests that interest-sensitive sectors such
as business fixed investment, housing and
consumer durables will bear the major
burden. The second view implies that U.S.
exportand import-competingindustrieswill
suffer most. In either case, deficits mustbe
financed and the private sector bears the
cost.
Michael Hutchison and Charles Pigott
An alternate view holds that foreigners will
be willing to increase their U.S. investments
substantially over an extended period,
making large current account deficits sus-
tainable. Political stability and the U.5.
policy allowing international capital to flow
in and outofour borders virtually unre-
stricted are two majorreasons foreigners
may readily increase their investments in
this country. In addition, U.5. current
accountdeficits amount to less than 10 per-
centofthegross savings offoreign industrial
countries as a whole, and to a much smaller
fraction oftheirwealth. Moreover, giventhe
dollar's standing as an investment and inter-
national reserve currency, foreigners may
considerinvestments indollarstobe as safe,
if notsafer, than investments in theirown
currencies. As long as the Fed maintains an
anti-inflationary monetary policy, advo-
cates ofthis alternative view believe that
there is no apparent reason why the U.S.
cannot continue to run very large current
accountdeficits as long as budgetdeficits
remain high.
Editorial comments may beaddressed totheeditor (Gregory Tong) orto the author....freecopiesof
this and other federal Reserve publications can beobtained by callingor writing the Public
Information Section, federal Reserve Bank ofSan francisco, P.O. Box 7702, San francisco 94120.
Phone (41S) 974-2246.
CurrentAccount
and the Business Cycle
Pe,,"'nlofCNP
-1""':"'-+--+0,..,,--
Aveli1geofSix
~Previous Cycles
5--:?'f"",,"--'--
3
This second argument suggests that
foreigners will be willing to finance large
U.S. current accountdeficits for the fore-
seeable future, and without any significant
risk premium. Ifso, continuingforeign
capital inflows should eventually relieve
pressure on domestic financial markets,
bringing U.S. real interest rates down.
-5-+-if-'r----
1--,-----
and significantly above world levels. (The
interest rate differential represents a risk
premium needed to induce foreigners to
hold an increased share oftheirwealth
in U.S. assets.)
-15__-,-_="'",-,3__
----,.~-,""------------------- .._.~-----"'-_._-_._-""-----------SSV'~ iSl:lI:l
UOltlU1YSEM. ytnn • uoSaJQ • EpEAaN • oyepi
nI?ME'H • E'!UJO)UE'J euozpv. IDjS!?lV
'J!llQ 'o:>sPUl?J.:I ues
ZSL 'ON 11WH3d
OIVd 3!>V1S0d 's'n
11VW 5S\!l315HB
CG>::D~Y::D\ill~JJ~ \ill~<S
~CG> 1:\I\ill~em
@AJJ@~@CQI U~JJ@l)5)@~
lj\ill<iiJWill:(lJ(\'l?<iJ]<iiJ<D] \\j];:])J(\'l? <iiJ~ <iiJ(QJ
BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and liabilities
Large Commercial Banks
Amount
Outstanding
1/4/83
Change
from
12/28/83
Change from
year ago
Dollar Percent
loans, Leases and Investments1 2 155.317 670 3.065 2.0
Loans and Leases1 5 175,984 1,145 2,263 1.3
Commercial and Industrial 45.832 622 - 172 - 0.3
Real estate 58.877 - 108 692 1.2
loans to Individuals 26,630 - 116 1,873 7.6
Leases 105 0 1 1.0
U.S. Treasury and Agency Securities2 12,506 1,470 1,316 11.8
Other Securities2 8,161 NA NA NA
Total Deposits 190,988 NA NA NA
Demand Deposits 49,232 3,616 3,785 8.3
Total Transaction Deposits 62,006 NA NA NA
Demand Deposits Adjusted 3 31,578 NA NA NA
Other Transaction Balances4 12,774 NA NA NA
Total Non Transaction Balancess 128,982 NA NA NA
Money Market Deposit Accounts-Total 39,596 NA NA NA
Time Deposits in Amounts of $100,00
or more 38,169 - 393 - 15,176 - 28.4
Other liabilities for Borrowed Money 22,978 2,936 - 1,095 4.5
Weekly Averages
of Daily.Figures
Member Bank Reserve Position
Excess Reserves (+)/Deficiency (-)
Borrowings
Net free reserves (-I-)/Net borrowed(-)
Weekended
1/4/84
333
57
276
Weekended
12/28/83
367
224
142
Comparable
year-ago period
297
21
276
Footnotes
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading account securities
3 Excludes deposits of u.s. government and commercial banks in U.s. and cash items in process
of collection
4 ATS, NOW, Super NOW and savings accounts with telephone transfers
5 Includes borrowings from Federal Reserve banks, treasury tax and loan notes, federal funds purchases
and securities sold under agreements to repurchase, and other borrowed money
6 Includes items not shown separately

Export crowding out

http://www.frbsf.org/publications/economics/letter/1984/el84-04.pdf

Export crowding out

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics