Global Adjustments to a Shrinking U.S. Trade Deficit
SINCE EARLY 1985,w hen the U.S. administration began to encourage the depreciation of the dollar to reduce the U.S. trade imbalance, there has been considerable discussion of the need for international policy coordination to bring about a "soft landing" in the world economy. Two kinds of recessionary risks have been widely discussed. The first is that the United States will do little about its budget deficit, so that foreigners will be called on to provide significant financing for many years to come. If they become reluctant to lend, then U.S. interest rates could soar, causing the dollar to collapse, and pushing the United States into a recessionary balance-of-payments crisis. The second recessionary risk starts from an almost opposite premise: that the United States will cut its budget deficit sharply, without a compensatory fiscal expansion abroad, and thereby throw the world into an aggregate demand slump. U.S. Treasury officials in the past three years have strongly urged more expansionary fiscal policies in Germany and Japan to avoid this outcome, and influential independent economists have concurred in this advice. This paper examines the prospects for reducing the U.S. trade imbalance and the plausibility of the hard-landing scenarios. A review of evidence on the sources of the trade deficit finds that the U.S. budget deficit is the most important, but not the only major, source. Reducing the budget deficit would help to reduce the trade deficit, but even if the budget deficit were eliminated, a substantial trade deficit would remain. Equally important, an attempt to reduce the trade deficit further by a depreciating exchange rate induced by easier monetary policy would, at this stage, produce inflation with little benefit on the current account.