Thursday, September 9, 2010

Trade Deficit Improves

Here's an article discussing the impact of a lower trade deficit and what it means for growth.  How does trade affect economic growth. Gross domestic product (GDP) is the market value of all final goods produced in a given period within a country. There are a couple GDP accounting methods. We will primarily focus on the expenditure approaches. This methods sums up household consumption, investment, government spending, and net exports (exports less imports). Household consumption include durable and nondurable goods and inventories. Investment accounts for business investment in new equipment, inventories, and new purchases of homes. Net exports are simply correcting for where the goods are produced. As you can see an increase in net exports will increase GDP, but does a reduction in our trade deficit necessarily result in a higher measure of GDP? If the reduction in the trade deficit occurs because of increase in exports, than yes a lower trade deficit will increase economic growth (economic growth is the annual rate of change of GDP). But if the trade deficit is lower because we have imported less, unless households have switched from buying foreign into buying U.S. than a reduction in the trade deficit will not necessarily improve growth. Alright so what is it?

The Bureau of Economic Analysis is responsible for measuring GDP and we won't know the effect on consumption until next quarter. But we can gain some insight into looking at the past data here. What can we learn? If we look at quarter four in 2009 we can see a large gain in exports ($83 billion), a modest increase in imports ($20 billion), and another modest gain in consumption ($20 billion). As we can see an increase in exports was the primary reason for an increase in GDP. This table shows the contribution to GDP by each component in quarter four of 2009 the economy grew at a 5% rate, and nearly half of this was from more exports.

What caused the increase in exports? The increase in exports is likely a function of an incease in income abroad and a lower dollar exchange rate. As you can see a decline in the value of the dollar (red line) corresponds closely with an increase in exports (blue line). This is one benefit of the dollar depreciation.

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