Saving-investment Imbalances Research Articles

The Relationship Between the German Current Account and Financial Account: Evidence from the Toda-Yamamoto Causality Approach

Abstract The paper examines the causality between the German current account and financial account. It contrasts with past research which assumes the current account and financial account to be jointly determined by a saving-investment imbalance. Our analysis decomposes the current account into exports and imports (real resource flows) and the financial account into domestic capital outflows and foreign capital inflows (gross capital flows). Evidence from the Toda-Yamamoto causality test shows that for Germany from Q1.1980 to Q2.2023, the causality runs from the financial account to the current account. It is not real resource flows but gross capital flows which exert significant impacts on the German real exchange rate. The finding implies that over the long run, strong German capital outflows and weak foreign capital inflows contributed to weak wage growth and stagnant investment in Germany, sustaining the persistent German current account surpluses. A reduction of the German current account surpluses requires a policy mix of fiscal expansion and monetary tightening which would expand the absorption of German and foreign capital in the German economy.

FOREIGN DIRECT INVESTMENTS AND ECONOMIC GROWTH: A CRITICAL LITERATURE REVIEW

The relationship between foreign direct investment (FDI) and economic growth has attracted major attention from academics and the governments of developing countries. Since economic growth is one of their main focuses, FDI attraction-related policies have been prioritized during the process of economic growth and development in these countries. It is widely observed that FDI mitigates the saving-investment imbalance and provides technology which is used for the production of goods and services. Although some studies have found evidence of the positive impact of FDI on economic growth, others have revealed the opposite result. The objective of this paper was to perform a critical theoretical and empirical literature review on foreign direct investments and economic growth. The theories guiding this study included the internalization theory, eclectic paradigm theory, product lifecycle theory, Solow growth model and endogenous growth theory. From the empirical studies reviewed, most studies conclude that foreign direct investments influence economic growth in a positive way but it is also evident that the studies also provide conflicting findings with some oscillating from negative to positive and others indicating no relationship at all. The difference in findings among the scholars might arise from methodological differences and operationalization of the study variables. Contextual differences might also explain the inconsistent findings as most of the studies have focused on developing economies. The study identified preconditions in the host country that help harness FDI and influence economic growth and they include developed financial and legal institutions, proper infrastructure, conducive monetary and fiscal policies, and an enabling macro-economic and structural environment that directs FDI to productive investments.

A simple macroeconomic model of a currency union with endogenous money and saving-investment imbalances

The great financial crisis has triggered new economic thinking about the functioning of an economy, and in the European case, of a currency union. Explanations of the macroeconomic relations inside a currency union are therefore in demand. It is now widely understood that sectoral debt and the current account should be part of a model. Traditional textbook models, like the IS-LM-BP or the IS-MR-PC models, respectively, are found lacking on the monetary or the real side, or both. This paper develops a model in order to fill this gap by constructing a simple model featuring endogenous money and saving-investment imbalances.

A Simple Model of a Currency Union with Endogenous Money and Saving-Investment Imbalances

The economic crisis in the euro zone proves that neither the creators of the euro nor today's policy-makers fully understand the functioning of a currency union. Explanations of the macroeconomic relations inside a currency union are therefore in demand. It is now clear that macroeconomic imbalances and debt levels should be part of a model. Traditional textbook models, like the IS-LM-BP or the IS-MR-PC models, respectively, are found lacking on the monetary or the real side or both. The one developed in the following has been created with the purpose of filling this gap and allowing the macroeconomic analysis of a currency union with the help of a simple model featuring endogenous money and saving-investment imbalances.

Investment-Saving Imbalances with Endogenous Capital Stock

The current consensus in macroeconomics, or New Neoclassical Synthesis (NNS), is based on dynamically stochastic general equilibrium (DSGE) modeling with a RBC core to which nominal rigidities are added by way of imperfect competition. The strategy is to minimize the frictions that are required to reproduce both persistent real effects of monetary policy and interaction of interest and prices in a rigorous framework with intertemporal optimization, forward-looking behavior and continuously clearing markets. Unfortunately this equilibrium framework do not allow to discuss the effects and the relations between financial markets and real economy, which were the core of the economic crisis of 2008. This paper presents a dynamic model with endogenous capital stock whereby it is possible to assess, and hopefully clarify, some basic issues concerning the macroeconomics of saving-investment imbalances.

Rebalancing Growth in the Republic of Korea

The current account surplus of the Republic of Korea (henceforth Korea) increased significantly in the immediate recovery period after the 1997–1998 Asian financial crisis. Since then the surplus has gradually diminished, and from 2006 to 2008, the current account was close to being balanced. Econometric analysis reveals that the effect of exchange rate changes on Korea's trade is not robust during non-crisis periods. Exchange rates only significantly affect trade when observations during crisis periods are included. This suggests that exchange rate adjustments alone will not solve the imbalance issue. Korea's external imbalances are not only caused by external factors; they also reflect internal and policy factors such as: (i) saving-investment imbalances; (ii) export-oriented policies; and (iii) the unbalanced structure of manufacturing and services. These internal imbalances result from domestic distortions and structural imbalances arising from market inefficiencies and public policies. These must be addressed to ensure balanced and sustained economic growth.

Beyond DSGE: A Macrodynamic Model with Intertemporal Coordination Failure

The current consensus in macroeconomics, or New Neoclassical Synthesis (NNS), is based on dynamically stochastic general equilibrium (DSGE) modelling with a RBC core to which nominal rigidities are added by way of imperfect competition. The strategy is to minimize the frictions that are required to reproduce Keynesian results (in terms of persistent real effects of monetary policy) and Wicksellian results (in terms of interaction of interest and prices) in a rigorous framework with intertemporal optimization of consumption, forward-looking behavior and continously clearing markets. In reality the main contention of Keynes and Wicksell was saving-investment imbalances (i.e. capital market failures and intertemporal disequilibrium in modern parlance) that are notably absent from the NNS. The paper presents a dynamic model with endogenous capital stock whereby it is possible to assess, and hopefully clarify, some basic issues concerning the macroeconomics of saving-investment imbalances and to explore the dynamic properties of the system under different monetary policy rules.

Have US external imbalances been determined at home or abroad?

This paper examines the relationship between the United States saving–investment imbalance and long-term real interest rates using a new international borrowing and lending framework. It first establishes how domestic or international factors may primarily influence the US external imbalance and interest rates over any given time before showing that the current account and real long term interest rate share a positive and statistically significant co-integrating relationship based on data from the mid-1980's. The results suggest that while in the pre-Asian financial crisis period (1985:01–1996:04) US external deficits and long term interest rates were mainly determined by domestic factors, external factors beyond the control of domestic policymakers dominated from 1997:01–2004:04.

Demographic Influences on Saving-Investment Balances in Developing and Developed Economies

This paper studies demographic differences between lower-income, less developed countries (the South) and higher-income developed countries (the North). It analyzes the implications of heterogeneous demographic evolutions for aggregate saving-investment imbalances, exchange rates, and the resulting net capital flows between North and South. An optimistic perspective suggests that the North can run a current-account surplus sizable in relation to the Northern economy, thereby transferring large net amounts of financial capital to the South. This paper argues that an optimistic perspective is a plausible characterization of demographic influences on North-South capital flows in the historical period between 1950 and the mid-1970s. For historical decades after the 1970s and for the initial decades of the 21st century, however, a less optimistic perspective is appropriate. Demographic forces considered by themselves are likely to diminish rather than augment the flow of Northern saving to the South as a fraction of the Southern economy. The fundamental causes of these effects are shifts in relative demographics between the South and the North. The qualitative conclusion holds regardless of whether the demographic transition in Southern economies is somewhat faster and sooner or somewhat slower and delayed, regardless of whether growth in Southern total factor productivity is vigorous or weak, and regardless of whether cross-border goods substitutability is modest or strong. Public policy concerned with demographic trends in higher-income Northern nations should recognize that demographic asymmetries with lower-income Southern economies are unlikely, by themselves, to ease resolution of Northern macroeconomic difficulties caused by population aging.

Has Foreign Capital Made Us Richer?

ustralia’s current account deficit approached seven per cent of GDP in 2004-05, one of its highest ever levels, renewing concerns in financial markets and economic policy circles about the sustainability of the economy’s balance of payments (see Edwards, 2005, Swan, 2005). External deficits of similar magnitude relative to GDP have recently been experienced by the United States, New Zealand and to a lesser extent by the United Kingdom. These deficits have been largely funded by high saving economies in East Asia, especially Japan and China, and oil exporting nations (see MacFarlane, 2005; International Monetary Fund, 2005). Financial market traders and policymakers worry that current account deficits of this size reflect poor international trade performance; that imports are too high and exports are too low. In addition, escalating external debt levels are considered inherently risky because over-reliance on foreign funds exposes an economy to sudden shifts in international investor sentiment and hence to capital flow reversals that could precipitate a currency and financial crisis, spark high inflation and induce a major recession (see, amongst others, Mann, 2002; and Fischer, 2003). The significance of current account deficits has been a long-running theme in Australian economic policy debate. As argued previously (Makin, 1989) at a time when the balance of payments was the central macroeconomic issue, external deficits are often best interpreted as saving-investment imbalances that allow real domestic capital accumulation to proceed more quickly. As a counter to concerns about external imbalances, it can therefore be argued that external deficits and matching capital account surpluses should actually be welcomed since they allow real investment to be higher. Similarly, in stock terms when foreign funds finance expansion of the domestic capital stock, the rise in external liabilities is matched by an increase in the level of productive plant, equipment and buildings. In sum, irrespective of its form net capital inflow allows more domestic capital accumulation which, if used for this purpose, improves the economy’s overall productive capacity. Numerous theoretical approaches have previously been advanced to demonstrate this (see, amongst others, Frenkel and Razin, 1987; McDougall, 1960; Grubel, 1987; Ruffin, 1987; and Makin, 2003). In the resurgent economic policy debate about Australia’s external imbalance, an important question not yet asked nor answered is: By how much has foreign capital raised Australia’s living standards? Or, in other words, how much better off, income-wise, have persistent current account deficits and rising foreign debt levels made us?

Back to Wicksell? In Search of the Foundations of Practical Monetary Policy

It is now widely held that the New Neoclassical Synthesis (NSS) offers central banks a user friendly, though rigorous, theoretical framework consistent with the current practice of systematic stabilization policy based on interest rate rules (e.g. Woodford (2003)). Particular interest and curiosity have been aroused by Woodford's argument that the NNS theory of monetary policy is in its essence a modern restatement and refinement of Wicksell's interest-rate theory of prices (1898a, b). This paper deals with two main issues prompted by Woodford's Neo-Wicksellian revival. The first questions the consistency between the NNS and Wicksell. The second concerns the value added for monetary policy of Wicksellian ideas in their own right. Section 2 clarifies some basic theoretical issues underlying the NNS and its inconsistency with a proper Wicksellian approach, which should be based on saving-investment imbalances that are precluded by the NNS theoretical framework. Section 3 presents a dynamic model whereby it is possible to assess, and hopefully clarify, some basic issues concerning the macroeconomics of saving-investment imbalances. Section 4 examines implications for monetary policy, in particular for Taylor rules, and section 5 concludes that there is some important lesson to be drawn from Wicksell (and Keynes) which is not in the NNS.

Two Sets of Twins? An Exploration of Domestic Saving-Investment Imbalances

Two Sets of Twins? An Exploration of Domestic Saving-Investment Imbalances

Trade in Financial Services and Capital Movements

International financial liberalization may alter saving-investment imbalances and patterns of capital flows across countries. In a panel of OECD countries for 1990-96, this study examines how the liberalization of capital movements and financial services trade affects net private capital flows. Capital inflows tend to fall (rise) with the liberalization of commercial presence in banking and securities (insurance) services, possibly reflecting an increase (decrease) in saving. Capital account liberalization is found to stimulate capital inflows, suggesting that better access to external financing helps sustain larger fiscal and current account deficits. When cross-border trade is liberalized, capital flows change insignificantly.

Trade in Financial Services and Capital Movements

International financial liberalization may alter saving-investment imbalances and patterns of capital flows across countries. In a panel of OECD countries for 1990–96, this study examines how the liberalization of capital movements and financial services trade affects net private capital flows. Capital inflows tend to fall (rise) with the liberalization of commercial presence in banking and securities (insurance) services, possibly reflecting an increase (decrease) in saving. Capital account liberalization is found to stimulate capital inflows, suggesting that better access to external financing helps sustain larger fiscal and current account deficits. When cross-border trade is liberalized, capital flows change insignificantly.