Large Current Account Imbalances Research Articles

Current Account Imbalances, Real Exchange Rates, and Nominal Exchange Rate Variability

AbstractThis paper globally analyzes the bivariate relation between large current account imbalances and the real exchange rate over different degrees of nominal exchange rate variability. Employing both linear and nonlinear panel estimation procedures, we typically find an inverse long-run link between large imbalances and the real exchange rate at lower nominal exchange rate rigidity levels. This is in contrast to the often non-existent or positive comovement that materializes under lower nominal exchange rate variation. Our results thus suggest that greater nominal exchange rate adjustment can induce a stabilizing “current account”-“real exchange rate” relation. Meanwhile, current account adjustment speeds up with more flexible nominal exchange rates. Along the cross-section, the most salient findings are i) the striking positive relation between current account persistence and real exchange rate persistence based on country-specific estimates and ii) the inverse correlation between persistence in either the current account or real exchange rate and nominal exchange rate volatility.

Revisiting external imbalances: Insights from sectoral accounts

This paper revisits the period of substantial widening of external imbalances in advanced economies in the run-up to the global financial crisis and their adjustment since then. We take a granular look at these imbalances through the lens of their domestic counterpart: the net financial balance of the household sector, the government, non-financial corporations, and financial corporations. Our findings challenge the often-claimed view that the household sector lies behind most of the dynamics of the current account. In fact, we show that it is non-financial corporations and the government that account for the bulk of: (i) the co-movement with the standard set of fundamental covariates of the current account; (ii) the external adjustment and expenditure reduction in the aftermath of the global financial crisis; and (iii) the diverging dynamics during large and persistent current account imbalances. These results emphasize that analyzing domestic sectoral balances can lead to a better empirical and theoretical understanding of global imbalances.

Import Dependency of Exports as a Cause of Current Account Deficit

The rapid increase in import dependency of exports and current account imbalances in many countries over the last two decades led many researchers to argue that they may be correlated and the increase in IDE may be the main cause of current account imbalances. This argument is important because historical evidence suggests that large and persistent current account imbalances often lead to subsequent corrective crisis. If the increase in IDE is a major cause of current account imbalances, reducing it becomes an important policy option to prevent further crisis. While there is a large literature on both global value chains (the main cause of IDE) and current account imbalances, the literature that investigates the link between them is very new and limited. This paper aims to contribute to this limited literature.

Revisiting the Current Account: Insights from Sectoral Balances

This paper revisits the period of substantial widening of external imbalances in advanced economies in the run-up to the global financial crisis and their adjustment since then. We take a granular look at these imbalances through the lens of their domestic counterpart: the net financial balance of the household sector, the government, non-financial corporations, and financial corporations. Our findings challenge the often-claimed view that the household sector lies behind most of the dynamics of the current account. In fact, we show that it is the non-financial corporation and the government sectors that account for the bulk of: (i) the co-movement with the standard set of fundamental covariates of the current account; (ii) the external adjustment and expenditure reduction in the aftermath of the global financial crisis; and (iii) the diverging dynamics during large and persistent current account imbalances. These results emphasize that analyzing domestic sectoral balances can lead to a better empirical and theoretical understanding of global imbalances.

The trinity of wage setting in EMU: A policy proposal

Diverging labor cost developments are often considered to be one of the most important factors that led to large current account imbalances in the euro area (EA) in the run-up to the global financial crisis. It has also been shown that wage growth differentials have significantly lowered the co-movement of EA countries’ business cycles – the most widely used meta-criterion for optimum currency areas. Against this background, this paper develops a wage-setting benchmark that aims to keep the economy in internal equilibrium and to maintain price stability, while it also exhibits the capacity to correct for external imbalances. The proposed wage benchmark is very simple and may serve as an anchor for the macroeconomic dialogue in Economic and Monetary Union. In order to demonstrate the potentially beneficial effects of such a wage benchmark we present some simulations showing how current account balances and labor costs would have developed across EA countries if the rule had served as a benchmark already in the run up to the crisis.

Exchange Rates and Capital Flows

Floating exchange rates were supposed to automatically restore the external balance of an economy, leaving monetary policy free to pursue domestic objectives, without the external constraint. There was also a promise that floating exchange rates would not, in fact, fluctuate much and would be rather stable thanks to speculation. Forty years of experience with floating rates do not support such claims. Floating exchange rates have proved to be volatile, have allowed large and persistent current account imbalances, have not relieved monetary policy form the external constraint and often, made it more difficult for monetary policy to achieve domestic policy objectives. What floating exchange rates made possible was the across-the-board liberalization of cross-border capital flows which, growing ever higher relative to real economy transactions, have turned the exchange rate, out of a policy instrument, into a mere by-product of the interplay of speculative forces.

The Adjustment of Current Account (Im-)Balances in Africa

Large current account imbalances are perceived to be a macroeconomic risk. Consequently a reversal (especially of a deficit) is often regarded as good in itself, and is frequently pursued as a policy objective or as part of reform programme. This perception is surprising in light of the intertemporal approach to the balance of payments, where international borrowing and lending - and therefore current account imbalances - result from rational economic decisions with a time dimension. But the theory does not settle the matter. Hence, this paper investigates the actual experience of current account reversals in Africa, the region where current account imbalances have been the largest (relative to GDP) in recent decades. We identify periods of current account reversal (both deficits and surpluses) and identify the associated development in real GDP growth, the real effective exchange rate, inflation, investment and aid inflows, both prior to and following the reversal. These results are compared with a control group. The results do not suggest that these reversals have been associated with either disruptive business cycle episodes or other macroeconomic risks in the sample group.

Changes in Eurozone Governance after the Crisis and the Issue of Growth

The Eurozone countries are still seeking a way out of the crisis that has been affecting the European Monetary Union (EMU) since 2010. Sovereign debt crises, difficulties in the banking system and large current account imbalances have characterized the euro crisis, while several countries of the Eurozone have entered a phase of slow and even negative growth. All this has put at risk the sustainability of the EMU, leading to a climate of distrust surrounding the future of the single currency. The crisis of the Eurozone has shown that a sustainable currency union requires more governance because of the higher degree of economic, financial and fiscal spillovers between euro member countries. However, the crisis has led to significant changes in the institutional framework of the EMU and in the economic policies of the Eurozone, highlighting, above all, the role of the ECB. The present contribution analyses these changes in Eurozone governance and discusses whether they are the correct solutions to the crisis; in addition it focuses on the unresolved issue of growth in the peripheral Eurozone countries.

TheGerman Model and theEuropean Crisis

AbstractThe large current account imbalances in the eurozone reflect persistent diverging trends between core and periphery countries, also fed by low interest rates and abundant capital flows brought about by the introduction of the euro. With the global financial crisis, the market sentiment has changed, and capital has left the periphery countries suffering from debt and growth problems due to their failure to bring price–wage dynamics into uniformity with those of the more disciplined countries.Germany is called upon to provide financial assistance and additional external demand; however, though the euro is at stake,Germans are recalcitrant. This article investigates the rationale of theGerman stance in light of the (corporatist‐etatist, neo‐mercantilist)German socio‐economic model and the widespread concern about losing the competitiveness thatGermany regained through painful reforms and changes in the last two decades.

Global Imbalances and Foreign Asset Expansion by Developing Economy Central Banks

In the aftermath of the Asian financial crisis of 1997–99, central banks and governments throughout the developing world have accumulated foreign exchange reserves and other official assets at an unprecedented rate. This paper shows that this official asset accumulation has driven a substantial portion of the recent large global current account imbalances. These net official capital flows have become large relative to the size of the industrial economies, and they are a significant factor contributing to the weakness of the economic recovery in the major industrial economies.Full publication: Are Central Bank Balance Sheets in Asia Too Large?

Rebalancing: Evidence from Current Account Adjustment in Europe

After the 2003-2007 economic boom, European countries with large pre-crisis current account imbalances are undergoing adjustments. Countries are adjusting at different paces and ways reflecting the source and magnitude of imbalances, availability of financing, competitiveness of the tradable sector and external environment. While emerging European countries with large pre-crisis imbalances and a fixed exchange rate regime have seen sharp current account adjustments and a rebound in growth, adjustment in the euro zone periphery countries, which are also carrying a legacy of pre-crisis CA imbalances, has been gradual with difficulties bringing back growth. This paper is an empirical investigation of current account adjustment in Europe with a focus on these two groups, looking at contributions from cyclical and other factors, and seeking to draw policy conclusions.

Rebalancing: Evidence from Current Account Adjustment in Europe

After the 2003-2007 economic boom, European countries with large pre-crisis current account imbalances are undergoing adjustments. Countries are adjusting at different paces and ways reflecting the source and magnitude of imbalances, availability of financing, competitiveness of the tradable sector and external environment. While emerging European countries with large pre-crisis imbalances and a fixed exchange rate regime have seen sharp current account adjustments and a rebound in growth, adjustment in the euro zone periphery countries, which are also carrying a legacy of pre-crisis CA imbalances, has been gradual with difficulties bringing back growth. This paper is an empirical investigation of current account adjustment in Europe with a focus on these two groups, looking at contributions from cyclical and other factors, and seeking to draw policy conclusions.

Remedies for the Eurozone Crisis: Quack and Otherwise

The on-going crisis of the eurozone is calling its continued existence into doubt, and raising questions on whether it can function effectively. The view of the nature of the eurozone crisis as arising from ‘design faults’ of the Economic and Monetary Union and a balance of payments crisis with large current account imbalances between countries is developed. The policy remedies (in the form of the ‘fiscal compact’) which are being put into place will not work in their own terms and will make the economic performance of the eurozone countries worse. Some Keynesian remedies for the crisis in terms of alternative policy proposals for the operation of the Economic and Monetary Union are outlined.

Does the Current Account Still Matter?

Do global current account imbalances still matter in a world of deep international financial markets where gross two-way financial flows often dwarf the net flows measured in the current account? Contrary to a complete markets or “consenting adults” view of the world, large current account imbalances, while very possibly warranted by fundamentals and welcome, can also signal elevated macroeconomic and financial stresses, as was arguably the case in the mid-2000s. Furthermore, the increasingly big valuation changes in countries’ net international investment positions, while potentially important in risk allocation, cannot be relied upon systematically to offset the changes in national wealth implied by the current account. The same factors that dictate careful attention to global imbalances also imply, however, that data on gross international financial flows and positions are central to any assessment of financial stability risks. The balance sheet mismatches of leveraged entities provide the most direct indicators of potential instability, much more so than do global imbalances, though the imbalances may well be a symptom that deeper financial threats are gathering.

Making Room for China in the World Economy

As it comes out of the crisis, the world econ omy faces two apparently conflicting demands. On the one hand, achieving global macroeco nomic stability and preventing a protectionist backlash will require that we avoid large current account imbalances of the type that the world economy experienced in the run-up to the cri sis. On the other hand, returning to rapid growth in the developing nations will require that they resume their conquest of global market share in tradable goods. The challenge of meeting both demands is epitomized by the contentious US-China bilat eral relationship. American (and European) policy makers blame China for an undervalued renminbi, which they argue is the root cause of China's huge trade surplus. Chinese leaders resist the pressure, fearing that appreciation will undercut the competitiveness of Chinese goods in world markets, hurt exports, and damage growth. The Western answer to this concern is that China needs to replace foreign demand with domestic demand as the engine of growth. But if growth depends primarily on the sup ply of modern manufactured products and other tradables as opposed to services and non-trad ables, as I will argue here, the Chinese position has more force than critics give it credit. The conventional fix for China's current account surplus, consisting of a combination of expendi ture expansion and currency appreciation, will shift the structure of the economy away from tradables and towards non-tradables. This may be good for macroeconomic balance in China and elsewhere, but it will almost certainly have adverse effects on China's growth?perhaps large enough even to endanger the country's social and political stability.

Asset prices, exchange rates and the current account

This paper analyses the role of asset prices in comparison to other factors, in particular exchange rates, as a driver of the US trade balance. It employs a Bayesian structural VAR model that requires imposing only a minimum of economically meaningful sign restrictions. We find that equity market shocks and housing price shocks have been major determinants of the US current account in the past, accounting for up to 30% of the movements of the US trade balance at a horizon of 20 quarters. By contrast, shocks to the real exchange rate have been less relevant, explaining about 9% and exerting a more temporary effect on the US trade balance. Our findings suggest that large exchange rate movements may not necessarily be the key element of an adjustment of today's large current account imbalances, and that in particular relative global asset price changes could be a potent source of adjustment.

Globalization and the sustainability of large current account imbalances: Size matters

This paper evaluates the sustainability of large current account imbalances in the era when the Chinese GDP growth rate and current account/GDP exceed 10%. We investigate the size distribution and the durability of current account deficits during 1966–2005, and report the results of a simulation that relies on the adding-up property of global current account balances. Excluding the US, we find that size does matter: the length of current account deficit spells is negatively related to the relative size of the countries’ GDP. We conclude that the continuation of the fast growth rate of China, while maintaining its large current account/GPD surpluses, would be constrained by the limited sustainability of the larger current account deficits/GDP of courtiers that grow at a much slower rate. Consequently, short of the emergence of a “new demander of last resort”, the Chinese growth path would be challenged by its own success.

Sequencing of reforms, financial globalization, and macroeconomic vulnerability

I use a large cross country data set and panel probit analysis to investigate the way in which the interaction between trade and financial openness affect the probability of external crises. This analysis is related to debate on the adequate sequencing of reform. I also investigate the role played by current account and fiscal imbalances, contagion, international reserves holdings, and the exchange rate regime as possible determinants of external crises. The results indicate that relaxing capital controls increases the likelihood of a country experiencing a sudden stop. Moreover, the results suggest that “financial liberalization first” strategies increase the degree of vulnerability to external crises. This is particularly the case if this strategy is pursued with pegged exchange rates and if it results in large current account imbalances. J. Japanese Int. Economies 23 (2) (2009) 131–148.

Globalization and the Sustainability of Large Current Account Imbalances: Size Matters

This paper evaluates the sustainability of large current account imbalances in the era when the Chinese GDP growth rate and current account/GDP exceed 10%. We investigate the size distribution and the durability of current account deficits during 1966-2005, and report the results of a simulation that relies on the adding-up property of global current account balances. Excluding the US, we find that size does matter: the length of current account deficit spells is negatively related to the relative size of the countries' GDP. We conclude that the continuation of the fast growth rate of China, while maintaining its large current account/GPD surpluses, would be constrained by the limited sustainability of the larger current account deficits/GDP of courtiers that grow at a much slower rate. Consequently, short of the emergence of a new demander of last resort, the Chinese growth path would be challenged by its own success.

Asset Prices, Exchange Rates and the Current Account

This paper analyses the role of asset prices in comparison to other factors, in particular exchange rates, as a driver of the US trade balance. It employs a Bayesian structural VAR model that requires imposing only a minimum of economically meaningful sign restrictions. We find that equity market shocks and housing price shocks have been major determinants of the US current account in the past, accounting for up to 32% of the movements of the US trade balance at a horizon of 20 quarters. By contrast, shocks to the real exchange rate have been much less relevant, explaining less than 7% and exerting a more temporary effect on the US trade balance. Our findings suggest that sizeable exchange rate movements may not necessarily be a key element of an adjustment of today's large current account imbalances, and that in particular relative global asset price changes could be a more potent source of adjustment.