Fiscal Policy and the Current Account: John Taylor is 20 Years Younger

John Taylor, the Treasury Undersecretary of Treasury for International Affairs, delivered an address on Policy Challenges of Global Payment Imbalances at the American Enterprise Institute yesterday. I learned about this address from Atrios and his post called “We’re All Keynesians Now”. Atrios points to this Washington Post Story , which included the following:

The large influx of foreign money shows that “sound, growth enhancing economic policies are continuing to make the U.S. an attractive place to invest,” he said. Taylor said administration policies already in place will help shrink the trade deficit. One is President Bush’s pledge to cut the budget deficit in half.. Taylor pointed out that the Treasury is also prodding foreign governments to achieve faster economic growth, which should increase demand for U.S. exports…

The premise that a rise in investment relative to national savings was the cause of an increase in the current account deficit reminded me as the excuses 20 years ago when the apologists for the Reagan deficits put forth this excuse. I figured Dr. Taylor would never be so careless but when we read the transcript, we see:

I’m going to focus a lot on the savings-investment gap… When a country, like the United States, is investing more than is being saved domestically, the rest of the investment is financed and comes from abroad, and that’s the current account deficit… There was a $112 billion increase in the current account deficit in the four quarters ending and the second quarter of this year. This is measured on national income accounts basis. Now, this corresponded to an increase in investment in the United States of $335 billion. That outstripped an increase in American saving of $224, and therefore the current account increase. Now, that increase in investment in the United States that occurred, the $335 billion, of course, was very important for the United States recovery this year. Growth has been strong… Now, let me talk a little bit about some of the economic policies that have been taken and will continue to be taken and indeed enhanced on in the Bush Administration to — that are quite related to the phenomenon of the current account and to the way that I’ve characterized this. First of all, in terms of the difference between investment and savings, clearly one of the — a policy that would raise savings is a policy that is — would tend — other things equal to reduce the current account deficit… as the President said, by half over the next four years. I think it’s important to note that there is — we’ve already seen with the recovery we have had the changes in the deficit. At the beginning of this year, both CBO and the Administration, forecast a larger deficit than has occurred thus far. It focused just on fiscal year ’04 which already closed. The Administration forecast a budget deficit for fiscal year ’04 which was a $108 billion larger than actually took place. In other words, because of the faster growth, largely because of the faster growth, the deficit came down relative to forecasts by $108 billion.

I agree with the focus on the savings-investment gap, but if one looks at the ratio of investment to GDP now versus where it was four years ago, the nation is investing less. The problem is that the Bush fiscal stimulus lowered national savings even more. Yes, the investment slump has been partially reversed as we did have decent economic growth over the last year. But this notion that the Federal deficit is falling simply is not true. We would hope that Bush would pursue fiscal restraint, but we see no evidence of any plans to do so.

Since my own posts on fiscal policy have played on the Mundell-Fleming model of how fiscal policy affects the current account under floating exchange rates, I just reached for my copy of Greg Mankiw’s 1992 edition of Macroeconomics. Chapter 13 notes that fiscal stimulus crowds out net exports. As I recall the discussion of this issue in Macroeconomics by Robert Hall and John Taylor is similar. I hope Dr. Taylor is correct about the future course of fiscal policy, but I found his AEI speech rather disappointing.