Is it sufficiently realized how intractable those U.S. imbalances -- and how dangerous their potential consequences at home and abroadÑhave now become?

Wynne Godley

English

Research Papers in Economics

The Levy Economics Institute of Bard College
Policy Note
2005 / 5
SOME UNPLEASANT AMERICAN
ARITHMETIC
 
Is it sufficiently realized how intractable those U.S. imbalances—and how dan-
gerous their potential consequences at home and abroad—have now become?
Recall first that, as all students of the national income know, the deficit of the general
government (federal, state, and local) is everywhere and always equal (by definition) to the cur-
rent account deficit plus the private sector balance (the excess of private saving over investment).
In the first quarter of 2005, the deficit in the U.S. balance of trade—the difference between
exports and imports—was 5.7 percent of GDP, implying that the current account deficit, which
includes both the trade deficit and certain forms of cross-border income, was at least 6 percent.
In the absence of major policy changes (and assuming output growth is sustained), many people
think that the current account deficit will increase further during the next four years. Suppose
optimistically, however, that the deficit remains at 6 percent while output growth remains high
enough to stop unemployment from rising.
The private sector balance was negative 2.2 percent in the first quarter of 2005—some 4 per-
cent below its long-term average—mainly because there has been a furious housing boom
financed by exceptionally high borrowing.It is noteworthy that between 1952 and 1997,there was
not a single whole year during which the private sector balance was negative. If, during the next
four years, the private sector balance were to recover halfway to normal (i.e., to zero), implying a
  is a Distinguished Scholar at the Levy Institute and a senior visiting research scholar at the Cambridge Endowment for
Research in Finance.
The Levy Economics Institute is publishing this research with the conviction that it is a constructive and positive contribution to the discussion
on relevant policy issues. Neither the Institute’s Board of Governors nor its advisers necessarily endorse any proposal made by the author.
Copyright © 2005 The Levy Economics Institutelarge fall in private expenditure relative to income, and if the
deficit in the current account remains at 6 percent, the general
government deficit must rise to equal the current account
deficit, that is, it must rise to 6 percent. This number follows
arithmetically because, as already pointed out, the budget
deficit is equal,by definition,to the current account deficit plus
the private sector balance. If the private sector balance were to
return to its long-term average (plus 1.8 percent),as might eas-
ily happen if the housing boom were to collapse, the govern-
ment deficit would have to rise to nearly 8 percent of GDP.
Neither of these figures for the budget deficit is credible,
given the administration’s firm commitment to cut the federal
deficit in half during the next four years. Yet without such
renewed fiscal stimulus, the United States will, at best,
encounter a prolonged growth recession under the (conserva-
tive) stated assumptions about international trade and the pri-
vate sector balance.
The current account problem, examined from the view-
point of aggregate demand, would not necessarily be solved
just if exports were to rise more than imports, because this
could simply be a manifestation of recession in the United States.
Sustained and balanced growth in the future requires that
exports rise faster than full-employment imports. Such a rise is
a necessary condition for achieving a reduction in the budget
and current account deficits simultaneously,without recession.
But the obstacles to sufficient export growth are daunting,
because the value of imports is now (in the first quarter of
2005) 57 percent higher than exports.Suppose that the volume
of imports rises at 8 percent per annum (the average growth
rate during the last 15 years) indefinitely, and that there con-
tinues to be no change in the non-oil terms of trade. (The
terms of trade are the dollar prices of imports relative to those
of exports.) 
In this case,the volume of exports would have to rise at an
annual average rate in excess of 10 percent during the next four
years—60 percent above the long-term average in the past—
just to prevent the balance of trade from deteriorating as a share
of GDP. To bring about a 3 percent (of GDP) improvement in
the balance of trade,sustained growth in exports would have to
exceed 16 percent per annum, which is very much faster than in
any previous four-year period.
Arithmetic by itself obviously will not tell us how much
export growth would be required to improve the deficit by 3
percent if there were a further devaluation of the dollar that
caused the terms of trade to deteriorate and import penetra-
tion to fall. I have simulated the future, using a range of
assumptions, and I find that any credible configuration
requires a sustained rise in the volume of exports at a rate well
in excess of 12 percent per annum—that is, faster than during
any previous four-year period. But where, in any case, would
these exports go? And does the United States now have suffi-
cient manufacturing capacity to supply them?
A 3 percent improvement in the current account balance
as a share of GDP would also require an equivalent reduction
in domestic demand for goods and services—in other words,
significantly reduced private consumption and investment.Are
the U.S. government and the U.S. public prepared for the large
rise in taxation and cuts in public services that are implied?
Finally, how is the rest of the world to manage, should
their main motor for growth—their growing trade surplus
with the United States—turn negative? Are they collectively
able and willing to generate adequate growth at home to com-
pensate for the loss?
What is going to force the strategic issue? It is not obvious
that a large enough change in exchange rates will occur soon or
spontaneously.Perhaps the loss of U.S.manufacturing jobs will
be the straw that breaks the camel’s back, but let’s hope the
Gordian knot isn’t cut by inaugurating a new era of piecemeal
protectionism. Martin Wolf (2005) was right when he claimed
that global imbalances require a global solution.
References
Wolf, Martin. 2005.“Imbalances Will Require Global 
Solutions.”Financial Times, April 26.
Policy Note, 2005 / 5Recent Levy Institute Publications
POLICY NOTES
Imbalances Looking for a Policy
 
2005/4
Is the Dollar at Risk?
 . 
2005/3
Manufacturing a Crisis: The Neocon Attack on Social Security
.  
2005/2
The Case for an Environmentally Sustainable Jobs Program
 
2005/1
Those “D” Words: Deficits, Debt, Deflation, and
Depreciation
.  
2004/2
Inflation Targeting and the Natural Rate of Unemployment
 
2004/1
LEVY INSTITUTE MEASURE OF ECONOMIC WELL-BEING
Economic Well-Being in U.S. Regions and the 
Red and Blue States
 .  and  
March 2005
How Much Does Public Consumption Matter for Well-Being?
 . ,  , and  
December 2004
How Much Does Wealth Matter for Well-Being? 
Alternative Measures of Income from Wealth
 . ,  , and  
September 2004
Levy Institute Measure of Economic Well-Being
United States, 1989, 1995, 2000, and 2001
 . ,  , and  
May 2004
Levy Institute Measure of Economic Well-Being 
Concept, Measurement, and Findings: United States,
1989 and 2000
 . ,  , and  
February 2004
STRATEGIC ANALYSES
How Fragile Is the U.S. Economy?
 . ,  . ,
.  , and  
March 2005
Prospects and Policies for the U.S. Economy: 
Why Net Exports Must Now Be the Motor for U.S. Growth
 ,  , and  
August 2004
Is Deficit-Financed Growth Limited? Policies and Prospects
in an Election Year
 . ,  . , 
.  , and  
April 2004
Deficits, Debts, and Growth: A Reprieve But Not a Pardon
 . , . , 
.  , and  
October 2003
This policy note and all other Levy Institute publications are 
available online on the Levy Institute website,www.levy.org.
To order a Levy Institute publication, call 845-758-7700 or 
202-887-8464 (in Washington,D.C.),fax 845-758-1149,e-mail
info@levy.org, write The Levy Economics Institute of Bard
College, Blithewood, PO Box 5000, Annandale-on-Hudson,
NY 12504-5000, or visit our website at www.levy.org.
The Levy Economics Institute of Bard College
 NONPROFIT ORGANIZATION 
U.S. POSTAGE PAID
BARD COLLEGE
The Levy Economics Institute of Bard College
Blithewood
PO Box 5000
Annandale-on-Hudson, NY 12504-5000
Address Service Requested
 

2005.“Imbalances Will Require Global Solutions.”Financial Times,

"Some Unpleasant American Arithmetic"

http://www.levyinstitute.org/pubs/pn_5_05.pdf

"Some Unpleasant American Arithmetic"

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics