In the bank's 1986 Annual Report,
we spelled out the close relation between this country's federal budget
and foreign trade deficits. Basically, the difference between what the
United States saves and what it invests is foreign capital. The supply
of foreign capital is measured by our foreign trade deficit. So, if
we want to diminish our reliance on foreign capital, that is, lower
the trade deficit, we must either raise national savings or lower domestic
investment. We argued that the most effective way of raising national
savings is to lower the federal budget deficit.
Two years have now passed since we first presented this analysis. How
have events played out? And, more importantly, where do we go from here?
To date, developments have generally been favorable, perhaps more favorable
than initially expected. Specifically, the budget deficit has declined
significantly from its 1986 peak, largely as a result of the spending
restraint embodied in the 1986 Budget Resolution and "enforced" by the
Gramm-Rudman-Hollings Act. At the same time, there has been modest improvement
in our trade balance and further appreciable expansion in domestic investment.
The performance of the overall economy in 1987-88 was good, and the expansion
was distinctly better balanced than in its first years.
Recent experience does not suggest, however, that somehow during the
past two years we evaded the strictures of the unpleasant arithmetic that
binds budget and trade deficits and the "savings surplus" (the difference
between domestic savings and investment). Rather, a key ingredient in
this positive performance was the significant reduction in the federal
fiscal deficit. Such a reduction permitted investment and trade to improve
If further progress along these general lines is to characterize the
economy this year and next, additional, sizable reductions in the budget
deficit must be achieved. If not, progress on the trade front will be
arrested and/or investment will be inhibited, unless domestic savings
That is, further action to reduce the government deficit can help to
sustain a balanced expansion that encourages, among other things, persistent
declines in the trade deficit. And, with the economy operating close to
capacity, additional fiscal restraint is appropriate to moderate demand
and temper inflationary pressures.
Furthermore, since the economic well-being of future generations depends,
in part, on investment decisions made today, a smaller budget deficit
potentially can contribute to higher living standards in the future, to
the extent that it promotes a favorable investment environment. Unfortunately,
a preliminary reading on this situation is not encouraging at this time.
The Congressional Budget Office has estimated the baseline federal deficit
for fiscal year 1990 at about $150 billion. The recent agreement between
Congress and the Administration appears to produce less than $10 billion
in real reductions in the year ahead. To the extent that we are concerned
about the future prosperity, we should continue to reduce the still wide
imbalance in our federal fiscal affairs.