Global Implications of the US Trade Deficit Adjustment

Abstract

Rebalancing the large U.S. trade deficits could take different paths. Based on model simulations, the paper shows that if rebalancing is based solely on a sharp cut in the U.S. domestic demand, a recession will be inevitable for the U.S. economy, and the adverse impact for the global economy will be substantial. On the other hand, if the adjustment relies mainly on an increase in demand from the rest of the world, the impact on the U.S. economy would be minimal. But it seems unfeasible for the rest of the world to boost demand, enough to eliminate the large deficits of the United States in the short- to medium-term. A feasible and benign adjustment therefore has to be a gradual process through both reducing the U.S. domestic demand and increasing demand from the rest of the world. The challenge for policymakers worldwide is to maneuver such a smooth adjustment.