The National Saving and Investment Identity

Self-Check Questions

Using the national savings and investment identity, explain how each of the following changes (ceteris paribus) will increase or decrease the trade balance:

  1. A lower domestic savings rate
  2. The government changes from running a budget surplus to running a budget deficit
  3. The rate of domestic investment surges


Write out the national savings and investment identity for the situation of the economy implied by this question: Supply of capital = Demand for capitalS +  (M – X) + (T – G) = I Savings +  (trade deficit) +  (government budget surplus)=Investment If domestic savings increases and nothing else changes, then the trade deficit will fall. In effect, the economy would be relying more on domestic capital and less on foreign capital. If the government starts borrowing instead of saving, then the trade deficit must rise. In effect, the government is no longer providing savings and so, if nothing else is to change, more investment funds must arrive from abroad. If the rate of domestic investment surges, then, ceteris paribus, the trade deficit must also rise, to provide the extra capital. The ceteris paribus—or “other things being equal”—assumption is important here. In all of these situations, there is no reason to expect in the real world that the original change will affect only, or primarily, the trade deficit. The identity only says that something will adjust—it does not specify what.

If a country is running a government budget surplus, why is (T – G) on the left side of the saving-investment identity?


The government is saving rather than borrowing. The supply of savings, whether private or public, is on the left side of the identity.

What determines the size of a country’s trade deficit?


A trade deficit is determined by a country’s level of private and public savings and the amount of domestic investment.

If domestic investment increases, and there is no change in the amount of private and public saving, what must happen to the size of the trade deficit?


The trade deficit must increase. To put it another way, this increase in investment must be financed by an inflow of financial capital from abroad.

Why does a recession cause a trade deficit to increase?


Incomes fall during a recession, and consumers buy fewer good, including imports.

Both the United States and global economies are booming. Will U.S. imports and/or exports increase?


A booming economy will increase the demand for goods in general, so import sales will increase. If our trading partners’ economies are doing well, they will buy more of our products and so U.S. exports will increase.