Question

Section 29.4 states that "the budget surpluses of the late 1990 s occurred at a time of then-record current account deficits." Holding everything else constant, what would the likely effect have been on domestic investment in the United States during those years if the current account had been balanced instead of being in deficit?

Short answer

If the current account had been balanced instead of being in deficit, domestic investment in the United States during the late 1990s would likely have been higher, as more resources would have been available domestically.

Step-by-step solution

Understanding the Current Account

The current account represents a country's net income over a period of time. There are mainly three components: the trade balance, net income from abroad, and net current transfers. A deficit in the current account means that the country is spending more on foreign trade, income, and transfers than it is earning.

Link Between Budget Surpluses and Current Account Deficits

In the late 1990s, the U.S had budget surpluses but current account deficits. With a budget surplus, the government spends less than it earns, freeing up resources that can be used elsewhere in the economy. However, a current account deficit implies that money is flowing out of the country to finance foreign spending, which could lead to a reduction in domestic investment.

Effect on Domestic Investment of Balanced Current Account

If the current account had been balanced, it implies that there would not have been a net outgoing of resources. It would mean the U.S was spending as much as it was earning from foreign transactions. As a result, there would be no need for domestic money to flow out to finance foreign spending. More available resources at home could have led to increased domestic investment if other economic factors remained constant.

Key concepts

Budget Surpluses

A budget surplus occurs when a government's revenue exceeds its expenditures over a certain period. This means the government is essentially saving money.
In the economy, this can have several effects, especially during the time when the U.S experienced it in the late 1990s.

• The government has more money available to pay off debts or to save for future expenses.
• It may also choose to reinvest surplus funds into the economy, potentially spurring growth.

When a government saves more than it spends, it can influence the rest of the economy by increasing the amount of available capital. If this capital is not needed to finance a deficit, like a current account deficit, it may be used to boost domestic investments or other areas in the economy.

Domestic Investment

Domestic investment refers to the funds put into projects within the country, such as infrastructure, technology, and businesses. It's essential for economic growth.
During the late 1990s in the U.S, the presence of a current account deficit meant that resources were leaving the country. However, if the current account was balanced, these resources could have been redirected.

• With a balanced current account, funds are not drained to finance international gaps, allowing more investments at home.
• Potentially resulting in an uptick in projects, job creation, or technological advances.

Thus, having a balanced current account could ideally lead to a more robust domestic investment environment.

Trade Deficit

A trade deficit is a situation where a country imports more goods and services than it exports. This contributes significantly to the current account balance.
When a trade deficit occurs, money flows out of the country's economy to purchase foreign goods.

• This can lead to reduced available resources, possibly affecting domestic investment.
• Countries often finance trade deficits by borrowing from foreign sources or drawing on reserves.

In the context of the U.S in the late 1990s, managing a trade deficit was crucial. If balanced or shifted, it could liberate funds typically used for foreign transactions. This might allow these funds to support domestic needs, such as expanding local businesses or infrastructure investments.