Trade Deficit and the Income Effect

The U.S. trade deficit continues to increase. Imports were outdistanced exports by $60.3 billion in November alone. American exports should be more in demand with the falling dollar. “By one estimate, if the dollar depreciates by 10%, the prices of American imports rise by just 2%,” reported The Economist. Why does this not follow the income effect? Americans need to live within their means. Europe is running a trade surplus. Why can’t we do the same?

The Federal Reserve says Americans believe they can live beyond their means because they assume their assets will appreciate. Hoping to even the scale, the Fed raised the interest rates to 2.25%.

1 comment:

Dr. Tufte said...

What does this have to do with ManEc?

This doesn't have anything to do with an income effect.

There is a little bit of information here indicating that import demand is very inelastic (-0.2).

It is common to interpret a trade deficit as a bad thing, and a surplus as a good thing, as done here.

Yet, under flexible exchange rates (which both the U.S. and the E.U. have), a trade deficit must be accompanied by an equal and opposite capital account surplus. The latter is a good thing. In Principles of Macroeconomics I call this economic "schizophrenia".