Do Current Account Deficits Matter.docx

Do Current Account Deficits Matter.docx

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DoCurrentAccountDeficitsMatter

DoCurrentAccountDeficitsMatter?

AtishGhoshandUmaRamakrishnan

THECURRENTaccountbalancemayseemtobeanabstruseeconomicconcept.Butincountriesthatarespendingalotmoreabroadthantheyaretakingin,thecurrentaccountisthepointatwhichinternationaleconomicscollideswithpoliticalreality.Whencountriesrunlargedeficits,businesses,tradeunions,andparliamentariansareoftenquicktopointaccusingfingersattradingpartnersandmakechargesaboutunfairpractices.TensionbetweentheUnitedStatesandChinaaboutwhichcountryisprimarilyresponsibleforthetradeimbalancebetweenthetwohasthrownthespotlightonthebroaderconsequencesfortheinternationalfinancialsystemwhensomecountriesrunlargeandpersistentcurrentaccountdeficitsandothersaccumulatebigsurpluses.

TheIMF,whosemandateincludespromotingandmaintaininganopeninternationaltradeandpaymentssystem,hasrecentlystartedmultilateralconsultationsonglobalimbalanceswiththemajorplayers:

China,theeuroarea,Japan,SaudiArabia,andtheUnitedStates.BacktoBasicstriestoremovetheemotionfromtheissueandexaminewhethercurrentaccountsurplusesanddeficitsevenmatter.

Measuringthecurrentaccount

Agoodstartingpointistoaskwhatacurrentaccountdeficitorsurplusreallymeansandtodrawinsightsfromthemanywaysthatacurrentaccountbalanceismeasured.First,itcanbeexpressedasthedifferencebetweenthevalueofexportsofgoodsandservicesandthevalueofimportsofgoodsandservices.Adeficitthenmeansthatthecountryisimportingmoregoodsandservicesthanitisexporting—althoughthecurrentaccountalsoincludesnetincome（suchasinterestanddividends）andtransfersfromabroad（suchasforeignaid）,whichareusuallyasmallfractionofthetotal.Expressedthisway,acurrentaccountdeficitoftenraisesthehacklesofprotectionists,who—apparentlyforgettingthatamainreasontoexportistobeabletoimport—thinkthatexportsare"good"andimportsare"bad."

Second,thecurrentaccountcanbeexpressedasthedifferencebetweennational（bothpublicandprivate）savingsandinvestment.Acurrentaccountdeficitmaythereforereflectalowlevelofnationalsavingsrelativetoinvestmentorahighrateofinvestment—orboth.Forcapital-poordevelopingcountries,whichhavemoreinvestmentopportunitiesthantheycanaffordtoundertakewithlowlevelsofdomesticsavings,acurrentaccountdeficitmaybenatural.Adeficitpotentiallyspursfasteroutputgrowthandeconomicdevelopment—althoughrecentresearchdoesnotindicatethatdevelopingcountriesthatruncurrentaccountdeficitsgrowfaster（perhapsbecausetheirlessdevelopeddomesticfinancialsystemscannotallocateforeigncapitalefficiently）.Moreover,inpractice,privatecapitaloftenflowsfromdevelopingtoadvancedeconomies.Theadvancedeconomies,suchastheUnitedStates,runcurrentaccountdeficits（seechart）,whereasdevelopingcountriesandemergingmarketeconomiesoftenrunsurplusesornearsurpluses.Verypoorcountriestypicallyrunlargecurrentaccountdeficits,inproportiontotheirGDP,thatarefinancedbyofficialgrantsandloans.

Onepointthatthesavings-investmentbalanceapproachunderscoresisthatprotectionistpoliciesareunlikelytobeofmuchuseinimprovingthecurrentaccountbalancebecausethereisnoobviousconnectionbetweenprotectionismandsavingsorinvestment.

Third,thecurrentaccountcanbeviewedintermsofthetimingoftrade.Weareusedtointratemporaltrade—exchangingclothforwinetoday.Butwecanalsothinkofintertemporaltrade—importinggoodstoday（runningacurrentaccountdeficit）and,inreturn,exportinggoodsinthefuture（runningacurrentaccountsurplusthen）.Justasacountrymayimportonegoodandexportanotherunderintratemporaltrade,thereisnoreasonwhyacountryshouldnotimportgoodsoftodayandexportgoodsoftomorrow.

Intertemporaltheoriesofthecurrentaccountalsostresstheconsumption-smoothingrolethatcurrentaccountdeficitsandsurplusescanplay.Forinstance,ifacountryisstruckbyashock—perhapsanaturaldisaster—thattemporarilydepressesitsabilitytoaccessproductivecapacity,thenratherthantakethefullbruntoftheshockimmediately,itcanspreadoutthepainovertimebyrunningacurrentaccountdeficit.Conversely,researchalsosuggeststhatcountriesthataresubjecttolargeshocksshould,onaverage,runcurrentaccountsurplusesasaformofprecautionarysavings.

Whenpersistentistoopersistent

Doesitmatterhowlongacountryrunsacurrentaccountdeficit?

Whenacountryrunsacurrentaccountdeficit,itisbuildingupliabilitiestotherestoftheworldthatarefinancedbyflowsinthefinancialaccount.Eventually,theseneedtobepaidback.Commonsensesuggeststhatifacountryfrittersawayitsborrowedforeignfundsinspendingthatyieldsnolong-termproductivegains,thenitsabilitytorepay—itsbasicsolvency—mightcomeintoquestion.Thisisbecausesolvencyrequiresthatthecountrybewillingandableto（eventually）generatesufficientcurrentaccountsurplusestorepaywhatithasborrowed.Therefore,whetheracountryshouldrunacurrentaccountdeficit（borrowmore）dependsontheextentofitsforeignliabilities（itsexternaldebt）andonwhethertheborrowingwillbefinancinginvestmentthathasahighermarginalproductthantheinterestrate（orrateofreturn）thecountryhastopayonitsforeignliabilities.

Butevenifthecountryisintertemporallysolvent—meaningthatcurrentliabilitieswillbecoveredbyfuturerevenues—itscurrentaccountdeficitmaybecomeunsustainableifitisunabletosecurethenecessaryfinancing.Whilesomecountries（suchasAustraliaandNewZealand）havebeenabletomaintaincurrentaccountdeficitsaveragingabout4½to5percentofGDPforseveraldecades,others（suchasMexicoin1995andThailandin1997）experiencedsharpreversalsoftheircurrentaccountdeficitsafterprivatefinancingwithdrewinthemidstoffinancialcrises.Suchreversalscanbehighlydisruptivebecauseprivateconsumption,investment,andgovernmentexpendituremustbecurtailedabruptlywhenforeignfinancingisnolongeravailableand,indeed,acountryisforcedtorunlargesurplusestorepayinshortorderitspastborrowings.Thissuggeststhat—regardlessofwhythecountryhasacurrentaccountdeficit（andevenifthedeficitreflectsdesirableunderlyingtrends）—cautionisrequiredinrunninglargeandpersistentdeficits,lestthecountryexperienceanabruptandpainfulreversaloffinancing.

Whatdetermineswhetheracountryexperiencessuchareversal?

Empiricalresearchsuggeststhatanovervaluedrealexchangerate,inadequateforeignexchangereserves,excessivelyfastdomesticcreditgrowth,unfavorabletermsoftradeshocks,lowgrowthinpartnercountries,andhigherinterestratesinindustrialcountriesinfluencetheoccurrenceofreversals.Morerecentliteraturehasalsofocusedontheimportanceofbalancesheetvulnerabilitiesintherun-uptoacrisis,suchastheextentofliabilitydollarizationandmaturitymismatches.Ithasalsounderscoredtheimportanceofthecompositionofcapitalinflows—forexample,therelativestabilityofforeigndirectinvestmentversusportfolioandothertypesofshort-terminvestmentflows.Moreover,weakfinancialsectorsoftenleadtohighervulnerabilitytoareversalasbanksborrowmoneyfromabroadandmakeriskydomesticloans.Conversely,aflexibleexchangerateregime,higherdegreeofopenness,exportdiversification,financialsectordevelopment,andcoherentfiscalandmonetarypoliciesaresomefactorsthatmakeacountrywithpersistentdeficitslessvulnerabletoareversal.

So,aredeficitsbad?

Acommoncomplaintabouteconomicsisthattheanswertoanyquestionis,"Italldepends."Itistruethateconomictheorytellsusthatwhetheradeficitisgoodorbaddependsonthefactorsgivingrisetothatdeficit,buteconomictheoryalsotellsuswhattolookforinassessingthedesirabilityofadeficit.

Ifthedeficitreflectsanexcessofimportsoverexports,itmaybeindicativeofcompetitivenessproblems,butbecausethecurrentaccountdeficitalsoimpliesanexcessofinvestmentoversavings,itcouldequallybepointingtoahighlyproductive,growingeconomy.Ifthedeficitreflectslowsavingsratherthanhighinvestment,itcouldbecausedbyrecklessfiscalpolicyoraconsumptionbinge.Oritcouldreflectperfectlysensibleintertemporaltrade,perhapsbecauseofatemporaryshockorshiftingdemographics.Withoutknowingwhichoftheseisatplay,itmakeslittlesensetotalkofadeficitbeing"good"or"bad":

deficitsreflectunderlyingeconomictrends,whichmaybedesirableorundesirableforacountryataparticularpointintime.

UnderstandingTheCurrentAccountInTheBalanceOfPayments

August182009|FiledUnder»Economics,Economy,FinancialTheory,Insurance,InternationalMarkets,Options

Thebalanceofpayments（BOP）istheplacewherecountriesrecordtheirmonetarytransactionswiththerestoftheworld.Transactionsareeithermarkedasacreditoradebit.WithintheBOPtherearethreeseparatecategoriesunderwhichdifferenttransactionsarecategorized:

thecurrentaccount,thecapitalaccountandthefinancialaccount.Inthecurrentaccount,goods,services,incomeandcurrenttransfersarerecorded.Inthecapitalaccount,physicalassetssuchasabuildingorafactoryarerecorded.Andinthefinancialaccount,assetspertainingtointernationalmonetaryflowsof,forexample,businessorportfolioinvestments,arenoted.Inthisarticle,wewillfocusonanalyzingthecurrentaccountandh