Answer to Question #173213 in Macroeconomics for zac

Question

 why a country with a lower budget deficit tends to increase its trade surplus? 

Answer 1

THE TWIN DEFICITS

A country with a lower budget deficit will always have an increase in its trade surplus. As the Keynesian perspective describes," a net-flow of foreign financial investments always accompanies a trade deficit, while a net-outflow of financial investment always accompanies a trade surplus."

This countries i.e. case study of USA between 1980s -2000 they always balanced their budget through the combination of tax cuts or spending increases, which increased aggregate demand in the economy, and some of that increase in aggregate demand will resulted in a higher level of imports.

A higher level of imports, with exports remaining fixed, will cause a larger trade deficit. That means foreigners holdings of dollars increase as Americans purchase more imported goods. Foreigners use those dollars to invest in the United States, which leads to an inflow of foreign investment. One possible source of funding our budget deficit is foreigners buying Treasury securities that the U.S.A government sells, thus a trade deficit often accompanies a budget deficit.

References

The White House. “This is why it’s time to make college more affordable.” Last modified August 20, 2013. http://www.whitehouse.gov/share/college-affordability.

Rubin, Robert E., Peter R. Orszag, and Allen Sinai. “Sustained Budget Deficits: Longer-Run U.S. Economic Performance and the Risk of Financial and Fiscal Disarray.” Last modified January 4, 2004. http://www.brookings.edu/~/media/research/files/papers/2004/1/05budgetdeficit%20orszag/20040105.pdf.