Read this excellent article by Martin Wolf in the Financial Times, and be sure to click on the chart, which I have also pasted below:
The private financial balance (net borrowing or net saving by households and businesses) plus the government financial balance must equal the net capital inflow from abroad. In the 2000s, the US was running a deficit in both the private and government accounts, which had to be offset by a positive net capital inflow from abroad. A net capital inflow for abroad must be offset by an equal current account deficit, which for the most part means a trade deficit.
Of the high-income countries, notice that in 2006 nearly all were running trade deficits, except Japan and Germany who were running trade surpluses. Also notice that Japan and Germany have been running a high positive private balance (i.e. businesses and households are high net savers). Japan and Germany have essentially been deflationary countries since the early 1990s, when the Japanese debt bubble burst and when Germany reunified. Both have been borrowing demand from abroad to partially offset their shortage of private demand.
The US, Spain, Ireland and the UK have been running private deficits. The US and the UK have been running private and government deficits. The twin deficits were therefore offset by large trade deficits.
Since the Great Recession, all of the countries listed have become high net private savers and all are running large government deficits. The large government deficits are necessary to offset the collapse in private demand. With all countries turning down at once, there would be no one to make up for domestic demand shortfalls. While international imbalances have become smaller, Japan and Germany remain net exporters and and the rest remain net importers.
As I have been saying over and over, for the US (and Spain, and Ireland and the UK) to dig out of the financial hole, we need to start running a trade surplus. Ideally that would come from an increase in foreign demand for US goods and services, and not by a deflationary bust in the US. For this to occur, a structural change will need to occur in the global economy that promotes balanced international capital flows. For a period we need countries like China, Japan and Germany to run trade deficits. Such a structural change does not seem at hand. Until that time, the US's only escape valve is for a weak dollar to support exports and to drive dollar investment abroad. The investment abroad will flow into emerging market financial bubbles, which will increase foreign demand and reduce the trade deficits in developed markets.
Without structural change, the likely outcome is continued high government deficits, low US interest rates, a weak dollar and financial bubbles in emerging markets. This is the trend to ride for this business cycle…just be sure to get off before it blows up.
One thought on “Government Deficits are Necessary (for now)”
it’s good to see this information in your post, i was looking the same but there was not any proper resource, thanx now i have the link which i was looking for my research.