Reducing the Deficits. What are the policy implications of these interdependent imbalances? Here are three:

• Tax incentives to encourage saving would likely also stimulate investment and lower both the budget deficit and the trade deficit.
• Reducing the budget deficit would reduce the vulnerability of the U.S. economy to foreign creditors; rising deficits could lead to foreigners dumping dollar assets, causing equities to decline, interest rates to spike and the dollar to plunge.
• Reducing the budget deficit doesn’t necessarily mean higher tax rates; marginal rate cuts reinforced by slower government spending growth would be ideal incentives.

Unfortunately, the recent tax “rebates” designed to stimulate the economy dealt a setback to budget discipline. Most people probably understand that. What they probably don’t understand is that the increased budget deficit will also tend to worsen our international balance of payments and weaken the dollar. The hip bone is connected to the thigh bone; so policymakers need to study these interconnected deficits. They need to borrow my boxes.