There is the tendency to view the U.S. current account imbalance as one that is becoming less pressing, with the September trade release, which showed a stabilization in the trade balance. However, a glance at the longer term trends reminds one that we still face the prospect of large imbalances going forward — as pointed out by Brad Setser.
Figure 1: Current account and net exports to GDP ratios. Source: BEA, October 27 release.
As Blanchard notes in the Mundell-Fleming lecture, entitled “Currenct Account Deficits in Rich Countries”:
“… I take up a specifc question, namely: Assume that current account deficits reflect private saving and investment decisions. Assume rational expectations. Is there any reason for the
government to intervene, and what is the optimal form of that intervention?
It is clear that the answer depends on the existence and the specifc form of distortions present in the economy. Thus, I start from a benchmark in which such distortions are absent, the equilibrium is the first-best outcome, and there is no role for government intervention. I then introduce various distortions, which
are often thought to be important in this context. In each case, I characterize the effect of the distortion on the equilibrium, and discuss the role of policy. Optimal policy is never geared to decreasing deficits per se; it may increase or decrease deficits.”
Possible distortions include sub-optimal governmental policy in the United States or China. One specific distortion may involve financial imperfections, such that business fixed investment has to be financed primarily by internal funds; this he relates to concerns about the long-term battering of the tradables sector I’ve discussed in previous posts here and here.
“Adjustment in the first best [case] implies first a decrease, then an increase (equal to twice the initial decrease) in tradables output. One worry is that it may indeed be diffcult for the tradables sector to expand after a long period of appreciation and low production.
One may think of a number of reasons why this may be. Internal costs of adjustment are not the issue: These will indeed affect the adjustment, and thus affect in turn first-period decisions and the current account deficit; but, absent other considerations, the outcome will still be the first best outcome, and there
is no role for government policy. Other distortions may however be relevant. Krugman (JDE, 1987) emphasized for example external learning by doing, and the fact that a long period of low production may lead to permanently lower productivity. Others have emphasized financial constraints, the fact that the tradables sector may not, after a long period of low profits, have the funds needed to invest and increase production later on.”
In the context of his model, he finds that there is a role for government spending policy. The policies should be aimed at increasing total spending on tradable goods, so as to mitigate the reduction in tradables in the second period. Since the model is one with a balanced budget (spending equals tax revenues), one can’t directly discuss whether budget deficits are a good idea or not. But the point of the lecture is not to provide specific prescriptions. Rather it is to highlight that, in order to argue for policy actions aimed at reducing the current account imbalance, one has to be clear about the source and magnitude of the distortions that drive the imbalance.
In my opinion, there are ample enough candidate distortions; a reckless U.S. fiscal policy, central bank intervention abroad (after all the Chinese and oil exporters’ saving and investment decisions are not wholely private sector-determined), negative externalities associated with oil consumption, and so forth. That is why sensible policies aimed at reducing the current account imbalance should focus on the sources of the deficit. Hence, like Blanchard, [I believe] trade restrictions are almost assuredly counterproductive. Unlike Blanchard, I think the budget deficit is a major source of the current account deficit.
[Late Addition 11/16 6:30am Pacific: New Economist also discusses Blanchard’s speech}.