US Fiscal Deficits Research Articles

Relative Prices and Hysteresis: Evidence from US Manufacturing

This study uses new measures of real exchange rates to study the collapse of US manufacturing employment in the early 2000s in historical and international perspective. To identify a causal impact of RER movements on manufacturing, I compare the US experience in the early 2000s to the 1980s, when large US fiscal deficits led to a sharp appreciation in the dollar, and to Canada's experience in mid-2000s, when high oil prices and a falling US dollar led to an equally sharp appreciation of the Canadian dollar. I use disaggregated sectoral data and a difference-in-difference methodology, finding that an appreciation in relative unit labor costs for the US lead to disproportionate declines in employment, output, investment, and productivity in relatively more open manufacturing sectors. In addition, I find that the impact of a temporary shock to real exchange rates is surprisingly long-lived. I explain the persistent effects of exchange rate movements on manufacturing using a Melitz model extension with sunk fixed costs, which leads to a dynamic gravity equation whereby shocks to trade have persistent effects that decay over time. The appreciation of US relative unit labor costs can plausibly explain more than two-thirds of the decline in manufacturing employment in the early 2000s.

Financial Crisis and Sustainability of US Fiscal Deficit: Indicators or Tests?

Whether or not budgetary policies are sustainable and can be conducted without creating the potential for government bankruptcy is a central question for macroeconomic analysis. In this paper, we show that indicators and tests to assess government solvency should not be used alternatively. We lay out a simple and intuitive procedure to integrate simultaneously the results from the two approaches to fiscal sustainability. Indicators are forward looking, for they are based on published forecasts, thus reacting to a set of current and expected future conditions in fiscal-policy making. Tests, by contrast, are backward looking, for they are based on a sample of past data. In the event of conflicting results, indicators may signal the occurrence of a structural change in policy, which may reverse the predictions of tests. Whether the results from indicators or from tests should be given priority in the assessment of the sustainability of public debt will thus depend on the structural stability of the historical data generating process of the primary surplus. Only in the absence of a structural break in the stance of fiscal policy, the potential warning predictions of fiscal indicators should be interpreted as merely reflecting transitory factors to be eventually reversed. An application to U.S. post-World War II historical data, from 1948 to 2016, and forecasts, from 2017 to 2027, demonstrates the empirical relevance of the proposed comprehensive approach and helps add new insights to the evaluation of the U.S. fiscal position. In particular, our results suggest that the potentially unsustainable course of U.S. fiscal policy from 2008 onwards, advocated by the use of fiscal indicators, reflects systematic—not cyclical—factors. The main policy implication is that deficit increases in the U.S. from 2008 onwards cannot be regarded as a transitory phenomenon and hence do entail an urgent need for a structural change in the future stance of budgetary policy.

The Empirics of Long-Term Us Interest Rates

US government indebtedness and fiscal deficits increased notably following the global financial crisis. Yet long-term interest rates and US Treasury yields have remained remarkably low. Why have long-term interest rates stayed low despite the elevated government indebtedness? What are the drivers of long-term interest rates in the United States? John Maynard Keynes holds that the central bank’s actions are the main determinants of long-term interest rates. A simple model is presented where the central bank’s actions are the key drivers of long-term interest rates through short-term interest rates and various monetary policy measures. The empirical findings reveal that short-term interest rates, after controlling for other crucial variables such as the rate of inflation, the rate of economic activity, fiscal deficits, government debts, and so forth, are the most important determinants of long-term interest rates in the United States. Public finance variables, such as government fiscal balances or government indebtedness, as a share of nominal GDP appear not to have any discernible effect on long-term interest rates.

The deficit-reduction debate in the USA: an investigation of cointegration and causality

The most recent financial crisis and the great recession have led to renewed questioning of the US fiscal deficit problem. This study revisits the relationship between government expenditures and revenues in the USA using the most recent datasets. It examines the long run relationship between spending and revenue by testing for integration using Engle-Granger and Johansen-Juselius methods of cointegration. Results from cointegration tests suggest that a long run relationship between expenditures and revenues exists in the USA. The Granger causality tests indicate that there is a bidirectional causal relationship between the two variables. Not only do the expenditures cause revenues but revenues in turn cause spending in the USA. The finding strongly supports the fiscal synchronisation hypothesis proposed by

Global financial architecture, global imbalances and the future of the dollar in a post‐crisis world

PurposeFinancial globalization and global imbalances are two facets of the same phenomenon, which has resulted in the worst global economic and financial crisis since the Great Depression. The purpose of this paper is to analyze the complex interaction of several mutually reinforcing trends and factors – the global monetary easing of 2001‐2004, financial innovation, regulatory failure, in particular in the USA and the UK, US fiscal indiscipline and Chinese currency manipulation – that contributed to the global financial crisis. The key to a return to global financial buoyancy will be the coordinated resolution of the global imbalances over the medium term, as well as the establishment of a strong global financial regulatory framework focusing on both macro‐ and micro‐financial risks.Design/methodology/approachIn the paper, the author analyzes the role of the interaction of financial innovation, regulatory and global imbalances in the creation of the real estate bubble, shadow banking and the eventual collpase of what the author dubbed the Banking 2.0 structure (1980s).FindingsThe main findings are that these factors contributed to a flattening of the yield curve in 2004‐2006 despite the tightening of monetary policy and growing US fiscal deficits. Moreover, while the US dollar is on a long‐term weakening trend, the lack of alternatives means that it will maintain its role as a reserve currency.Originality/valueThis paper focuses on the role of the global imbalances in triggering the financial crisis and shaping the role of the dollar in the post‐crisis world.

Regime shifts in stock-flow I(2)-I(1) systems: the case of US fiscal sustainability

In the last two decades, fiscal sustainability has been tested through the use of non-stationary time series analysis. Two different approximations can be found in the literature: first, a univariate approach that has focused on the stochastic properties of the stock of debt and, second, a multivariate one that has focused on the long-run properties of the flows of expenditures and revenues, i.e., in the stochastic properties of the deficit. In this paper we unify these approaches considering the stock–flow system that fiscal variables configure. Our approach involves working in an I(2) stochastic processes framework. Given the possibility of the existence of regime shifts in the sustainability of US deficit that the literature has pointed out, we develop a new statistic that can be applied to test several types of I(2) cointegration and multicointegration relationships allowing for regime shifts. To test for these kinds of changing long-run relationships we propose the use of a residual-based Dickey–Fuller class of statistic that accounts for one structural break. We show that consistent estimates of the break fraction can be obtained through the minimization of the sum of squared residuals when there is I(2) cointegration. The finite sample performance of the proposed statistic is investigated by Monte Carlo simulations. The econometric methodology is applied to assess whether the US fiscal deficit and debt are sustainable. Copyright © 2010 John Wiley & Sons, Ltd.

How will the related variables change if global imbalances unwind?

Since the US current account deficit (over 6%) is relatively large, many economists have questioned its sustainability. This paper aims to examine the relationship between the US trade balance and related economic variables by constructing a six-dimensional version of the structural vector autoregression (SVAR) model. According to our empirical results, a reduction in the US fiscal deficits cannot reduce the US imbalances. Despite reduction in trade deficits, the US recession can damage the world economy. The expansion of overseas economies is required to reduce global imbalances without global recession. One of our implications is that foreign countries should increase domestic demand.

Currency Asymmetry, Global Imbalance, and Rethinking Again of International Currency System

The US dollar has been volatile and falling again and again in recent decades as well as recent years, and for many observers, it is going to be broken sooner or later. The central importance of the dollar is due to the fact that it is not just a currency for the US. Over half of all dollar bills in circulation are held outside of the US borders, and almost half of the US Treasury bonds are held as reserves by foreign central banks. The US dollar is supposed to be the anchor that stabilizes the currency market. Instead, today it is a major source of instability. In the back ground, the US fiscal deficits have been running high again under Bush administration, once up to almost 3% of US GDP. And current account deficit is set to about 7% in 2005 and more volatility is widely expected. The situation is very challenging for the central banks of Japan, China, Korea, Taiwan and Singapore which collectively hold about US$2.8 trillion worth of US Treasury bonds as part of their reserves. The moment that they reduce their purchases, the value of the dollar slips. Yet, the more they buy, the more they are exposed to a potential free fall of the US dollar. China has been blamed, not only by US congressmen who are understandably not very familiar with either the complicated currency issues or the domestic politics in any other country, but also many economists or business strategists. It was said that it was all because RMB did not reevaluate, as the source of this global and currency instability. How much revaluation of RMB would remove the US deficits of $700 billions, or at least the US-China trade deficits $200 billions (including Hong Kong)? 500% or 1000%? Of cause no body asked for that kind of magnitude now. Normally smart people say 30-50%, with the unsaid intention to blame-then-suggest again another 30-50% after some initial moves, then the third, the fourth. This seems not really new phenomena at all. It has been all so familiar before and since the Nixon shock in early 70s', and in 80s' when there was the Plaza Accord. The convenient targets to blame were the gold standard, the Dutch Mark, the Japanese Yen. Now it is turn for Chinese reminbi. So the question is what are the real causes of the imbalance and currency instability? In this short paper, we first take a look at what is really going on with the Chinese economy and trade balance, and then try to identify sources of the current imbalance , and then, as a concluding remark, think again the possibilities to reform the currency system.

Those Current Account Imbalances: A Sceptical View1

The international current account imbalances, where the United States has a vast deficit, and several countries, notably Japan, China, Germany and the oil exporters have corresponding surpluses, are usually seen as problems. The argument here is that current account imbalances simply indicate intertemporal trade – the exchange of goods and services for claims. There are likely to be gains from trade of that kind as from ordinary trade. What, then, are the problems? This paper considers five scenarios, notably one where net savings of the surplus countries decline so that the world real interest rate rises, and another where the US fiscal deficit is reduced, so that the world real interest rate falls and there could be a worldwide aggregate demand problem, essentially caused by the high net savings of the surplus countries. The paper reviews the reasons for the large surpluses in terms of savings and investment ratios (especially China) and also discusses the long‐term problem for the United States. While four of the scenarios involve a decline in the dollar, they do not necessarily imply a sudden – and even ‘disruptive’– dollar crisis.

Do Asian investors rebalance their portfolios and what are the consequences?

This paper explores empirically whether Asian investors, and in particular foreign reserve managers, respond to capital gains or losses by rebalancing their portfolios of US Treasury securities. For a sample of 10 Asian countries from 1990 to end 2004, we find that capital losses – stemming from dollar depreciation against the euro or lower returns on US Treasury securities – increase the net purchases of such securities. The fact that Asian investors appear to rebalance their portfolios should reduce the likelihood of one-directional movements in the net purchases of US securities. Given the sheer size of the US fiscal deficit, much of which financed by Asian investors, this should have contributed to limiting the volatility of the international monetary system.

Comments on M. Dooley and N. Roubini: A new Bretton Woods system?

These excellent papers focus mainly on one issue: the question of a hard landing for the US Dollar. This is far from the only question raised by monetary arrangements across the Pacific. But I will start with the hard landing—discussing its drivers and mechanisms—and then go on to consider other costs and risks, and some wider implications of the very different experience we are having within Europe and within the Pacific region. Regarding drivers, the fundamental questions in the papers are: what is driving developments in the fixed rate Pacific region; and if this is mainly China, does that mitigate risks of a hard landing? First, I accept Nouriel Roubini’s description of the structural deterioration in the US fiscal deficit as a separate and exogenous driver. There are countries for which “financing ease” can drive the fiscal deficit, but this has not been the case for the United States, where budgetary developments are unarguably driven “above the line.” Nonetheless, I do see the dominant and most significant driver in our present context being the policies of countries, such as China, that are preventing real appreciation. In the case of China, I agree with Michael Dooley that this has to be viewed as a matter of development strategy. That strategy is concerned not only with export-driven growth (which, as Nouriel says, does not require large trade surpluses). It is concerned also with an insurance motive of holding large reserves to ensure policy autonomy in the face of shocks. In the view of many observers, the strategy is also designed to cushion adjustment in the domestic financial system. I can well imagine that China has internalised the cost of future capital losses on its US Treasury bond holdings as part of that strategy. Like Nouriel, I do not completely buy the “total return swap” argument. But I do think that China’s strategic approach IEEP (2006) 3:333–336 DOI 10.1007/s10368-006-0065-1

Adjustment of Global Imbalances and Its Impact on China's Economy

The present paper discusses ways of adjusting the imbalances of the global economy and its impact on China's economy. The analysis in the paper shows that the cut of US fiscal deficits and the appreciation of the currencies of East Asia, including China's RMB, are necessary for a smooth adjustment of the global imbalances. The adjustments will have a positive impact on China's economy and will help China realize its external balance. The increase in public spending on the service sector along with the appreciation of RMB will help China realize the internal balance too. The adjustment of the global imbalances will create opportunities and an external pushing force for China in its industrial restructuring and shift in the model of economic growth. (Edited by Xinyu Fan)

Transpacific Trade Imbalances: Causes and Cures

This paper explores the causes of the transpacific trade imbalances using an empirical global model. It also evaluates the impact of various policies to reduce these imbalances. We find the fundamental cause of trade imbalance since 1997 is changes in saving‐investment gaps, attributed to the surge of the US fiscal deficits and the decline of East Asia's private investment after the 1997 financial crisis. Our simulation results show that a revaluation of East Asia's exchange rates by 10 per cent (effectively a shift in monetary policy) cannot resolve the imbalances. We find East Asia's concerted efforts to stimulate aggregate demand can have significant impacts on trade balances globally, but the impact on the US trade balance is not large. US fiscal contraction is estimated to have large impacts on the US trade position overall and on the bilateral trade balances with East Asian economies. These results suggest that in order to improve the transpacific imbalance, macroeconomic adjustment will need to be made on both sides of the Pacific.

Expansionary Fiscal Shocks and the US Trade Deficit*

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.

Is the US fiscal deficit sustainable?: A fractionally integrated approach

In this paper, we examine if sustainability of the US fiscal deficit holds by means of studying the univariate properties of the difference between expenditures and public revenues using a methodology based on fractional processes. Furthermore, we incorporate the possibility of structural breaks in the deficit process. The results show that when allowing for a break in the mid-1970s, the public deficit in the US is an I( d) process with the fractional integration parameter d being slightly less than unity, implying that the fiscal deficit is mean reverting, and thus, sustainable, though the adjustment process towards equilibrium will take a very long time.