Expansionary Fiscal Shocks and the US Trade Deficit*

Abstract

AbstractIn this paper, we use a dynamic general equilibrium model of an open economy to assess the quantitative effects of fiscal shocks on the trade balance in the United States. We examine the effects of two alternative fiscal shocks: a rise in government consumption, and a reduction in the labour income tax rate. Our salient finding is that a fiscal deficit has a relatively small effect on the US trade balance, irrespective of whether the source is a spending increase or tax cut. In our benchmark calibration, we find that a rise in the fiscal deficit of 1 percentage point of gross domestic product (GDP) induces the trade balance to deteriorate by 0.2 percentage point of GDP or less. Noticeably larger effects are only likely to be elicited under implausibly high values of the short‐run trade price elasticity, or of the share of liquidity‐constrained households in the economy. From a policy perspective, our analysis suggests that even reducing the current US fiscal deficit (of 3% of GDP) to zero would be unlikely to narrow the burgeoning US trade deficit significantly.