Double deficit (economics)

An economy is deemed to have a double deficit (also known as a twin deficit) if it has a current account deficit "and" a fiscal deficit. In effect, the economy is giving claims on domestic assets to foreigners in exchange for foreign-made goods. Traditional macroeconomics predicts that persistent double deficits will lead to currency devaluation/depreciation that can be severe and sudden.

In the case of the United States, the twin deficit graph as a percentage of GDP shows that the budget and current account deficits did move broadly in sync from 1981 until the early 1990s, but since then, they have moved apart. Data thus confirms that as a government budget deficit widens, the current account falls, but the relationship is complicated by what happens to investment and private saving.

$CA(X-M)\; =\; (private)S\; +\; I\; +\; (T-G)$

$Current\; Account\; =\; (Private\; Savings\; -\; Investment)\; +\; (Tax\; -\; Government\; Expenditure)$

Above the equation, it's verifiable that CA will deteriorate as government expenditure exceeds the amount of tax is collected.

One way to understand this process intuitively is by thinking through two different markets. First consider the Foreign Exchange market. At equilibrium the quantity supplied=the quantity demanded. Thus, Imports + Capital outflow=Exports + Capital Inflow. Rearranging this equation we find that Imports-Exports=Capital Inflow-Capital Outflow. Because Imports-Exports=Trade Deficit and Capital Inflow-Capital Outflow=Net Capital Inflow, we get the equation Trade Deficit=Net Capital Inflow (or Current Account deficit = Capital Account Surplus).

Next we must consider the market for loanable funds. The equilibrium here is Savings+Net Capital Inflow=Investment+Budget Deficit. However, taking the Forex market into consideration we know that the Trade Deficit is equal to Net Capital Inflow. We can thus substitute for:

$Savings\; +\; Trade\; Deficit\; =\; Investment\; +\; Budget\; Deficit.$

Rearranging algebraically we find that:

$Budget\; Deficit\; =\; Net\; Savings\; +\; Trade\; Deficit\; -\; Investment.$

What we can gather from this is the understanding of why an increased budget deficit goes up and down in tandem with the Trade Deficit. This is where we derive the appellation the Twin Deficits: if the US budget deficit goes up then either household savings must go up, the trade deficit must go up, or private investment will decrease.

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