Current account imbalances

Doomsday or soft landing?

Literature• *Blanchard, O (2006), “Current account deficits in rich countries,” IMF speaker’s series • Ricardo Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas, “An equilibrium model of global imbalances

and low interest rates,” January 2006. MIT working paper 06-02.• Dooley, M., D. Folkerts-Landau and P. Garber (2004a) The Revived Bretton Woods System: The Effects of

Periphery Intervention and Reserve Management on Interest Rates & Exchange Rates in Center Countries NBER Working Paper No. 10332, March.

• Engel and Rogers, 2006, “The US current account deficit and the expected share of world output,” NBER Working Paper No. 11921

• *Bernanke, Ben [2005], “The Global Saving Glut and the U.S. Current Account Deficit,” available at http://www.federalreserve.gov/boarddocs/speeches/2005/20050414/default.htm.

• Obstfeld, Maurice [2004], “External Adjustment”, unpublished manuscript, University of California at Berkeley.• *Obstfeld, Maurice and Kenneth Rogoff [2005], “The Unsustainable US Current Account Position Revisited,”

November 2005.• Backus, David and Frederic Lambert [2005], “Current Account: Fact and Fiction,” unpublished manuscript, New

York University.• Gourinchas Pierre-Olivier and Helen Rey [2003] “The International Financial Adjustment, ” unpublished

manuscript, Princeton University.• Lane Philip and Gian Maria Milesi-Ferretti [2004] “The External Wealth of Nations: Measures of Foreign Assets

and Liabilities for Industrial and Developing Nations,” Journal of International Economics 55, 263-294.• Roubini Nouriel and Brad Sester (2005), “Will the Bretton Woods Regime 2 Unravel Soon? The risk of a hard

landing in 2005-2006,” unpublished manuscript, the Symposium by the Federal Reserve Bank of San Francisco and UC Berkeley, San Francisco, February 4th, 2005.

Current account deficits in rich countries

• Over the past 20 years, current account deficits have increased in rich countries

• These deficits reflect private saving-investment decisions

• Are these deficits too large?

• What kind of adjustments are needed?

Causes of current account imbalances

• US based– trade deficit

• lost competitiveness • high demand for imported goods

– low savings, high consumption pattern• wealth effect: stock market bubble, housing market

boom

– unusually high fiscal deficits due to Bush tax cut, and the war on terror

Causes of current account imbalances

• Saving glut (Ben Bernanke)

• Europe based– aging population (high savings)– lack of investment opportunities due to high

capital to labor ratio

• Emerging economies and oil exporters– export driven model of development– lack of investment opportunities at home

Global adjustments

• Steady state (Bretton Woods II) (Dooley, Folkerts-Landau and Garber (2004)

• Hard lending or doomsday scenario (Roubini and Sester)

• Slow to moderate adjustment (Obstfeld and Rogoff)

Bretton Woods II

• Asian countries finance US CA deficit– Major developing currencies pegged to US

dollar– export driven development– relocation of labor from rural China and India

to tradable sector

• Europe does not play major role• US absorbs savings of the rest of the

world

Doomsday scenario• Nouriel Roubini and Brad Sester http://www.rgemonitor.com/• Emerging market CBs stop buying US assets (Central banks

financed 90% of the United States’ $530 billion current account deficit in 2003)

• Housing market crush in US leads to loss of wealth by households and increase savings

• risk a disorderly unraveling of the Bretton Woods 2 system:– sharp correction of the US dollar and of the US bond market– surge in US long-term interest rates– sharp fall in the price of a wide variety of risky assets (such a equities,

housing, high-yield bonds, and emerging market sovereign debt) • sharp economic slowdown in the US. • It will force countries that now depend on US demand growth for

their growth to adjust as well.

Unsustainable US current account position revisited

• Obstfeld and Rogoff 2005– two country model of the world economy– θ is the (constant) elasticity of substitution

between tradable and nontradable goods– η is the (constant) elasticity of substitution

between domestically-producedand imported tradables

Savings glut

• Bernanke– too high savings in the rest of the world– US plays the role of vacuum cleaner and

absorb the excess savings– Need for more investment and consumption in

the emerging economies

Role of governments

• Blanchard– Taken the current imbalances as given, does it reflect

market imperfections or it is optimal behavior of the households?

• high saving in China reflects in part the lack of retirement and health insurance

• low investment in parts of Asia reflects poor financial intermediation

• Low saving in the United States reflects in part public dissaving; private saving itself maybe based on incorrect expectations about retirement benefits and health care

– Reducing these distortions, or in the last case, reducing the scale of deficit, is clearly desirable

Current situation: mixed signals

• Doomsday scenario has not materialized

• US dollar depreciate against all major currencies

• Trade balance, however, does not respond to dollar depreciation

• Housing market in US is slowing down

• Interest rate is low