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Current account deficit in USA

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The media and others suggest that the current account deficit run by the U.S. is a problem for the economy. What do you think? What action(s) would you advise federal government officials to take on this issue?

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Carbaugh, Robert J. International Economics, 10th edition. Mason, Ohio: Thomson/South-Western. 2005

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Solution Summary

This solution states that the current account deficit run by the US is a problem for the economy and why in approximately 719 words.

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Yes, it is true that the increasing current account deficit is a problem for the US economy in a number of ways:

First, as a component of aggregate demand, a growing trade deficit reduces the growth of domestic demand as American spending is diverted from domestic goods to foreign substitutes.

Second, because it represents foreign saving coming to the United States, it reduces American interest rates and encourages the growth of interest-sensitive domestic spending by businesses on such things as plant and equipment and by households on housing, automobiles, and appliances. On balance, however, the net effect on spending is negative.

There is a third and indirect effect which must also be considered. Lower interest rates in the U.S. encourages higher equity or stock market prices. Since equities are a major part of the financial wealth of households, higher equity prices are thought to be an important determinant of consumer spending and, thus, a positive influence on aggregate demand. In fact, this may play a large role in the current economic expansion.

Fourth, the inflow of foreign capital ...

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