Some excerpts from a recent conference on Current Account Sustainability in Major Advanced Economies
As part of a long term project on current account sustainability in major advanced economies, Charles Engel and I organized a conference that just finished up today. Sponsored by the University of Wisconsin Center for World Affairs and the Global Economy (along with the Robert M. La Follette School of Public Affairs, the Economics Department, and EU Center), the meeting brought about thirty participants from policy institutions (Fed system, ECB, IMF) and universities (European University Institute, Trinity College Dublin, and Virginia, Warwick, Frankfurt, Wisconsin). In contrast to some other conferences, the papers focused on empirical and theoretical modeling, rather than policy prescriptions.
We will be posting a set of proceedings from the conference (including abstracts, discussants’ comments, and general discussion), but in the meantime, I thought it would be interesting to highlight the main points of the papers. About half of the papers can be thought of as focusing on the determinants of current account imbalances, while the other half focus on the manner in which adjustment will take place. In today’s post, I’ll recount the main points of the the first set of papers, with the others covered in a subsequent post. I want to stress that these are the views of the authors, rather than mine (or for that matter, of their respective institutions).
Explaining the Global Pattern of Current Account Imbalances,” co-authored by Joseph Gruber and Steve Kamin:
This paper assesses some of the explanations that have been put forward for the global pattern of current account imbalances that has emerged in recent years: in particular, the large U.S. current account deficit and the large surpluses of the Asian
developing economies. Based on the approach developed by Chinn and Prasad (2003), we use data for 61 countries during 1982-2003 to estimate panel regression models for the ratio of the current account balance to GDP. We find that a model that includes as its
explanatory variables the standard determinants of current accounts proposed in the literature — per capita income, relative growth rates, the fiscal balance, demographic variables, and economic openness — can account for neither the large U.S. deficit nor large Asian surpluses of the 1997-2003 period. However, when we include a variable representing financial crises, which might be expected to restrain domestic demand and boost the current account balance, the model explains much of developing Asia’s swing into surplus since 1997. Even so, the model cannot explain why the capital outflows
associated with Asia’s current account surpluses were channeled primarily into the U.S. economy. Observers have pointed to strong growth performance and a favorable institutional environment as elements attracting foreign investment into the United States,
and we found strong evidence that good performance in these areas significantly reduces the current account balance. While a model incorporating these factors still fails to predict the large U.S. current account deficit (and, in fact, predicts a slight surplus), it
does predict a U.S. current account balance that is relatively weaker than the aggregate balance of developing Asia.
“Twin Deficits: Squaring Theory, Evidence and Common Sense,” co-authored by Giancarlo Corsetti and Gernot Muller:
Appealing to the twin deficit hypothesis, according to which shocks to the government budget move the current account in the same direction, many observers call for fiscal consolidation in the
US as a necessary measure to reduce the large external imbalance of this country. We reconsider the international transmission mechanism in a standard two-country two-good business cycle model, and find that fiscal expansions have no effect on the trade balance and thus on the current account i) if the economy is not very open to trade and ii) if fiscal shocks are not too persistent. Under these conditions, the crowding out effect of fiscal shocks on private investment is stronger than conventionally believed. We take this insight to the data and investigate the transmission of fiscal shocks in a VAR model estimated for Australia, Canada, the UK and the US. For the US and Australia, which are less open to trade than Canada and the UK, we find that the external impact of shocks to either government spending or budget deficits is limited, while private
investment responds significantly — in line with our theoretical prediction. The reverse is true for Canada and the UK. These results suggest that a fiscal retrenchment in the US may have a limited
impact on its current external deficit. However, our results do not weaken the case for fiscal consolidation: by crowding in investment, a fiscal correction will strengthen the ability of the US
to generate resources required to service future external liabilities.
“Productivity Shocks, Budget Deficits and the Current Account,” co-authored by Matthieu Bussiere, Marcel Fratzscher, and Gernot Muller:
Currently the U.S. is experiencing record budget and current account
deficits, a phenomenon familiar from the “Twin Deficits” discussion of the 1980s. In contrast, during the 1990s productivity growth has been identified as the primary cause of the US current account deficit. We suggest a theoretical framework which allows to evaluate empirically the relative importance of budget deficits and productivity shocks for the determination of the current account. Using a sample of 21 OECD countries and time series data from 1960 to 2003 we find little evidence for a contemporaneous effect of budget deficits on the current account, while country-specific productivity shocks appear to play a key role.
I don’t want to editorialize, but I will make one observation: by and large these papers do not ascribe a large role to fiscal policy in driving movements in the current account balance (although the Corsetti and Muller paper does imply an important role for fiscal policy in small open economies).