Beryl Sprinkel meets Ben Bernanke

There is no problem with the balance of payments because it’s always balanced. [a paraphrase of a quote of Beryl Sprinkel, CEA Chairman, 1985-89]

By economic definition, a country’s current and capital account balances must offset one another. Therefore, the U.S. current account deficit was matched by a capital account surplus of $668 billion (including $85 billion in net statistical discrepancies within the capital account, which are included in part to ensure the accounts sum to zero). [page 125, Economic Report of the President, 2006]

The Economic Report of the President is a publication with dual purposes. The first is pedagogic, laying out basic economic principles for a general audience. The second is didactic, seeking to persuade the undecided. This year’s international finance chapter is provocatively titled “The Capital Account Surplus”, to remind readers that, in an accounting sense, Beryl Sprinkel’s characterization is correct. Define CA as the current account, KA (technically termed the capital and financial account) as net capital inflows; then:

(where “==” means “identically equal to”.) But there is another sense of the term “balance of payments”, and the ERP completely sidesteps this definition. Break down the net capital inflows into private capital flows (KF) and official reserves transactions (ORT); then

which occurs when ORT is zero. Now the ERP does mention in Box 6-1 on page 129 that if one examines only the U.S. side of official reserves transactions, then it looks like we’re in equilibrium according to this condition (only $3 billion net change in official reserves assets). This is the sense in which the 2006 ERP revisits Beryl Sprinkel’s view of the balance of payments under floating exchange rates. Of course, if we lump into ORT both US and foreign official transactions (as the textbooks I have do), then the picture looks a lot different. The change in that category was about $415 billion. This point regarding the composition of flows to the US is the same that has been made by Nouriel Roubini and Brad Setser. While not incorrect, the authors of the ERP have not been fully transparent in their discussion of capital flows, and what constitutes “official reserve transactions”. In addition, it is important to recall that private capital flows are, by definition, private in that they do not pertain to central bank or monetary authority transactions. As Martin Feldstein has pointed out, some unknown proportion of the private capital flows are undertaken by government and quasi-governmental enterprises. Hence, one should be a little cautious about taking the remainder of the capital flows as a vote in favor of the U.S. economy’s prospects.

Here’s another interesting aspect of the chapter. One virtue of the ERPs of the past has been the caveats that are usually attached to strong assertions of economic behavior. But in this edition, there is an uncharacteristically unhedged assertion on page 146:

The interdependence of the global financial system implies that no one country can reduce its external imbalance through policy action on its own. Instead, reducing external imbalances requires action by several countries. Specifically, at least four steps may help to reduce these imbalances.

But this is not true, even taking the chapter’s premises at face value. In box 6-3 assessing “the link between fiscal and trade deficits”, the authors cite favorably the Fed’s estimate of an elasticity between fiscal and trade deficits of 0.20. They don’t note that this result from a calibrated model (Sigma) is at the low end of the estimates. The OECD macroeconometric model incorporates an elasticity of about 0.40, while the IMF’s calibrated model implies an elasticity of 0.50.

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Economic Report of the President