How closely related are the twin deficits?

Michael Maiello | Jun 27, 2017

Sections Economics

The United States may have twin deficits, but they are hardly identical. The fiscal deficit is the difference between what the federal government spends and the revenues it takes in. The trade deficit, in contrast, is the difference between the value of imports and exports.

But though the fiscal and trade deficits measure different things, the “Twin Deficit Hypothesis” posits that the two are correlated, so that a reduction in the fiscal shortfall will lead to a reduction in the trade deficit. But is that hypothesis borne out in practice?

To help explore that question, Chicago Booth’s Initiative on Global Markets asked its Economic Experts Panel whether or not a reduction in the fiscal deficit would result in a lower trade deficit. A plurality of the panel suggested that it would—but nearly as many panelists expressed uncertainty. Many of the experts posited that the effect on the trade deficit would depend on what steps the government took to reduce the fiscal deficit.

Though US President Donald Trump has expressed concern about the US trade deficit, there’s reason to think the US is heading for fiscal-deficit expansion. It may be awhile, therefore, before the hypothesis is put to the test in the American economy.

Michael Greenstone, University of Chicago
“It depends on how private saving/investment responds. I'm unaware of decisive empirical evidence of this (but perhaps it exists).”
Response: Uncertain

Eric Maskin, Harvard
“Depends on how the fiscal deficit reduction is achieved. If through higher consumer/income taxes, then trade deficit would probably decline.”
Response: Uncertain

Pete Klenow, Stanford
“It depends on how the budget deficit is reduced, of course.”
Response: Agree