What this lesson teaches
I can explain the causes of weak growth, unemployment, inflation or deflation and a large trade imbalance.
Syllabus 9570, 3.2.2(a). Macroeconomic Issues: Macroeconomic issues and their causes; Undesirable economic growth - persistently low or negative, unsustainable, non-inclusive due to factors such as changes in AD or AS, environmental degradation, inequitable income distribution; Unemployment - demand-deficient, structural, frictional due to factors such as lack of AD, technological changes, mismatch of skills, transition between jobs; Price instability - demand-pull inflation, cost-push inflation, deflation due to factors such as changes in AD, costs of production, productive capacity; Persistently large balance of trade deficit or surplus due to factors such as changes in global conditions, international competitiveness, exchange rates
Make a guess
A country runs a trade deficit because it is importing machines for new factories. Is this a worry?
- Not necessarily: the machines may raise future exports.
- No. Trade deficits do not matter while the currency is strong.
- Yes. A deficit means more money leaves than enters, so it weakens growth.
Show the answer
Not necessarily: the machines may raise future exports.
A deficit that pays for productive equipment can pay for itself. Judge a deficit by its cause and how it is financed.
A persistent trade deficit can signal weak competitiveness, but it can also reflect imports of equipment that raise future output.
A trade deficit means the value of imports is greater than the value of exports.
Causes include weak foreign demand, loss of price or non-price competitiveness, a strong exchange rate, and strong domestic spending that sucks in imports.
A persistent, large deficit can be a problem: it reduces AD, may cost jobs in export industries, and must be financed by borrowing from abroad or selling assets.
But not every deficit is harmful. If the imports are machines and equipment that raise productivity, the deficit may pay for itself through higher future output and exports.
- Causes
- Weak competitiveness, strong currency, strong domestic spending.
- Not always bad
- Imports of equipment can raise future output.
Worked example: A deficit from importing equipment
Exports are 120 and imports 100, a surplus of 20. Then imports rise to 140 while exports stay at 120. The extra imports are equipment that will raise productivity.
- The balance moves from a surplus of 20 to a deficit of 20.
- The imported equipment raises future productive capacity.
- If it makes exports more competitive, the deficit may be temporary.
- Judge a deficit by its cause and whether it can be financed, not just its size.
Watch out for this
A trade deficit is always bad for the economy.
It depends on why. Importing productive equipment can raise future growth.
Check your understanding
Which trade deficit is most likely to be a concern?
- A large deficit that persists because exports have become uncompetitive.
- A small deficit in one year during a boom, when households buy more imports.
- A short deficit from importing new machinery.
Show the answer
A large deficit that persists because exports have become uncompetitive.
Right. It reflects a lasting weakness and must be financed year after year.