Trade and Fiscal Deficits, Tax Reform, and the Dollar: General Equilibrium Impact Estimates

Trade and Fiscal Deficits, Tax Reform, and the Dollar: General Equilibrium Impact Estimates. Peterson Institute for International Economics. Working Paper, 17-9. William R. Cline. August 2017

Advocates of using a border tax adjustment (BTA) to shift the corporate profits tax to a “destination” basis argue that such an arrangement would not be protectionist, because the import tax and export subsidy would be fully offset by an induced appreciation of the dollar. To examine this claim, this study applies an updated and extended general equilibrium model from the author’s 2005 book, The United States as a Debtor Nation. Cline finds that across various scenarios, the dollar appreciation typically would be less than half the amount needed to offset fully the BTA. Advocates of the BTA implicitly assume a strong, prompt expectational boost to the dollar upon announcement of the shift. Instead, market practitioners and mainstream macroeconomic models see the interest rate as the main driver of the exchange rate. Although an incipient rise in the trade balance would indeed put upward pressure on the interest rate and thus the exchange rate, it would also result in reduced investment. With the trade deficit equal to investment minus saving (I–S = M–X), reduced investment would tend to set the new equilibrium at a lower trade deficit before the interest rate would rise sufficiently to boost the dollar to a level that would completely offset the BTA. [Note: contains copyrighted material].

[PDF format, 31 pages, 424.32 KB].

Will Rising Interest Rates Lead to Fiscal Crises?

Will Rising Interest Rates Lead to Fiscal Crises? Peterson Institute for International Economics. Policy Brief, 17-27. Olivier Blanchard and Jeromin Zettelmeyer. July 2017

A balanced, broad-based economic recovery seems under way in all major regions of the world. Managing the recovery poses challenges in the short run but they appear relatively benign. Looking forward, however, the authors see a set of new risks: (1) Partly because of the crisis and partly because of subsequent low growth, public debt has reached postwar historical highs in many advanced countries; (2) productivity growth, and with it potential growth, has declined. Whether it remains low or picks up in the future is uncertain; (3) interest rates are expected to increase from their current low levels. By how much and at what pace is—again—uncertain; and (4) many advanced countries have strong populist movements (or even populist leaders) espousing risky macroeconomic policies. The authors warn that rising interest rates, combined with low growth, high debt, and populist pressure, would be a recipe for fiscal crises. [Note: contains copyrighted material].

[PDF format, 7 pages, 172.09 KB].