How does a trade deficit affect GDP?

Question

How would an increase in the trade deficit affect GDP?

As per the majority of sources I’ve read such as Investopedia, they claim that GDP would decrease due to a decrease in the NX component of the GDP formula. However, as far as I know the C, I, G and X components include domestic but also imported goods and services. That’s why in order to avoid an overstated reading, we subtract imports in the end. Please correct me if I’m wrong here.

So the way I see it in that sense is that GDP would only fall if there was a decrease in C, I, G and X of domestic goods & services meaning the trade deficit could widen and have no effect on GDP as long as those 4 elements were to remain constant.

Answer 1

You are correct in most of your arguments.

but Note that $ GDP = C + I + G + (X - M) $

M is rather just an accounting variable, since GDP measures only the domestic production, there is a need to substract M from imported expenditures.

However, note that $ NX = X - M$ which also includes the export variable, therefore if there is a trade deficit due to decrease in X we should expect decrease in GDP as well.

The main point is that Trade deficit may or may not lead to decrease in GDP depending on the source of the deficit.

This article has detailed explanation on how imports is used in GDP computations.