BALANCE OF PAYMENTS DEFICIT

Balance Of Payments Deficit

Table of Contents

Introduction3

Investment Income Balance3

Why the Trade Deficit Widens4

A Saving-Investment Imbalance6

Other Factors That Influence International Capital Flows8

Instability9

Effects on Total Output and Employment11

Effects on Particular Sectors13

Conclusion14

References18

Balance Of Payments Deficit

Introduction

International trade continues to grow in importance for the world economy as well as the U.S. economy, enhancing economic well-being generally, but also imposing costs on trade sensitive sectors of national economies. The importance of trade has been well-recognized by Congress, which in recent years has paid close attention to many dimensions of U.S. international trade performance. This report examines the trade deficit, paying special attention to why it continues to widen, why it may be a problem, and what can be done to correct it. (http://www.imf.org)

Investment Income Balance

In 2006, the balance in the U.S. investment income account moved up from a surplus of $11. billion in 2005 to a surplus of $36. billion. The investment income balance is a tally of what U.S. foreign investments earn against what foreign investments in the U.S. earn. This pattern of surplus seems inconsistent with the rapid growth of foreign assets in the United States relative to the stock of U.S. assets in the rest of the world. Nevertheless, since 1998, the surplus in investment income has exhibited a rising trend, even as U.S. net indebtedness to the rest of the world increased sharply. The investment income surplus reached $46. billion in 2003 and fell to $30. billion in 2004. The persistence of the U.S. investment income surplus through 2006 is the result of the interplay of several forces. First, U.S. investments abroad on average earn a higher return than foreign investments do in the United States. This differential is thought to result from a higher incidence of mature, high yielding, assets in the U.S. investment portfolio, greater risk exposure, and the special status of the dollar as the worlds reserve currency of choice. (http://www.imf.org)

Second, the sharp fall of interest rates between 2000 and 2004 translated into a fall in the rate of return as a large portion of U.S. foreign debt is repeatedly rolled over. Third, in the period 2002 to 2006, a falling dollar, particularly against the euro, caused the foreign currency value of U.S. foreign assets and the associated earnings to rise. In the long run, however, it is likely that the United States' large and still growing stock of net foreign indebtedness will come to dominate movement of this balance and lead to steadily larger deficits in the investment income balance.

Why the Trade Deficit Widens

A rising current account deficit (or a falling surplus) over the course of a brisk economic expansion is not a remarkable event for the U.S. economy. In the 1960s, brisk economic growth steadily eroded a small current account surplus. In the 1970s, modest deficits occurred with each economic expansion. However, from the 1980s through 2006, the average size of the trade deficits steadily increased. Cyclical factors certainly have at times played some role in this phenomenon, particularly in recent years with the ...