Relationship Between Saving, Investment, Fiscal Balance, and Trade Balance

To understand the relation between savings, investments, fiscal balance, and trade balance, we will combine the income and expenditure approach to calculating GDP.

We know that,

GDP = C + I + G + (X – M)

We also know that,

GDP = C + S + T

Where,

C = Consumption spending

S = Government and household saving

T = Net taxes

We can equate the above two equations:

C + I + G + (X – M) = C + S + T

The government deficit (G – T) deficit can be expressed in terms of savings and investments as follows:

(G – T) = (S – I) – (X – M)

G – T represents government deficit

S – I represents excess of private savings over private investments

X – M represents trade surplus. A negative (X – M) represents trade deficit.

From the above equation we can conclude that:

Trade deficit (G – T >0) must be finance by:

1. Excess of private savings over private investments (S – I > 0), or
2. Trade deficit (X – M < 0), or
3. Combination of both