““Do Do CurrentCurrent Account Account Deficits Matter?”Deficits Matter?”

By Atish Ghosh and Uma By Atish Ghosh and Uma RamakrishnanRamakrishnan

Order of inquiryOrder of inquiry

What is the current account balance and What is the current account balance and how is it determined?how is it determined?

What is a current account deficit?What is a current account deficit? Does it matter how it is measured or Does it matter how it is measured or

defined?defined? What causes a current account deficit?What causes a current account deficit? Do current account deficits matter?Do current account deficits matter? So, do current account deficits really So, do current account deficits really

matter?matter? ImplicationsImplications

What exactly is the current account What exactly is the current account balance and how is it determined?balance and how is it determined?

The current account balance is part of the Balance of The current account balance is part of the Balance of Payments (BOP)Payments (BOP)

BOP is the record of all of a countries international BOP is the record of all of a countries international transactionstransactions

BOP = CA (current account) + FA (financial account) and BOP = CA (current account) + FA (financial account) and must equal zeromust equal zero

BOP is also represented by the following equation:BOP is also represented by the following equation: (X-IM) + Sf +rf +Tf =0 (X-IM) + Sf +rf +Tf =0 (X-IM) + Tf +rf represents the Current Account and Sf (X-IM) + Tf +rf represents the Current Account and Sf

represents the Financial Accountrepresents the Financial Account X=Exports , IM=Imports, Tf=intl. transfers, rf=returns on X=Exports , IM=Imports, Tf=intl. transfers, rf=returns on

assets, Sf=inflow of foreign savingsassets, Sf=inflow of foreign savings The current account thus records the flows of goods, The current account thus records the flows of goods,

services and transfers and the current account services and transfers and the current account balance reflects the net flow of goods, services and balance reflects the net flow of goods, services and transfers including gifts. transfers including gifts.

Measuring the Current AccountMeasuring the Current Account

According to Ghosh and Ramakrishnan According to Ghosh and Ramakrishnan the current account can actually be the current account can actually be measured three ways: measured three ways:

1.1. CA is “the difference between the value CA is “the difference between the value of exports of goods and services and the of exports of goods and services and the value of imports of goods and services.”value of imports of goods and services.”

2.2. CA is “the difference between national CA is “the difference between national (both public and private) savings and (both public and private) savings and investment.”investment.”

3.3. CA can be viewed in terms of the timing CA can be viewed in terms of the timing of trade.of trade.

What is a current account deficit?What is a current account deficit?

A current account deficit occurs A current account deficit occurs when the current account balance is when the current account balance is negative which means that a country negative which means that a country is spending more abroad then it is is spending more abroad then it is taking in. taking in.

The U.S Current Account Balance The U.S Current Account Balance for 2002 (U.S. $ Billions)for 2002 (U.S. $ Billions)

Source: Data from the Bureau of Economic Analysis, U.S. Department of Commerce, published online January 28, 2004. Source: Data from the Bureau of Economic Analysis, U.S. Department of Commerce, published online January 28, 2004.

+Credits: Sources of Foreign +Credits: Sources of Foreign ExchangeExchange

A: Exports of goods $681.9A: Exports of goods $681.9Trade balanceTrade balance

C: Exports of services (fees C: Exports of services (fees earned, transportations receipts, earned, transportations receipts, foreign tourism to U.S. etc.) foreign tourism to U.S. etc.) $292.2$292.2

Services balanceServices balance

E: Income Receipts $255.5E: Income Receipts $255.5Income BalanceIncome Balance

Current account balanceCurrent account balance

-Debits: Uses of Foreign Exchange-Debits: Uses of Foreign Exchange B: Imports of civilian goods B: Imports of civilian goods

$1,164.7$1,164.7= Deficit of $482.8= Deficit of $482.8

D: Imports of services (fees paid D: Imports of services (fees paid out, transportation charges, U.S. out, transportation charges, U.S. tourism abroad, etc. $227.4tourism abroad, etc. $227.4

= Surplus of $64.8= Surplus of $64.8

F: Income payments $259.5F: Income payments $259.5= Deficit of $4.0= Deficit of $4.0

G: Net unilateral transfers (gifts) G: Net unilateral transfers (gifts) $58.9$58.9

= A + C + E - (B + D + F + G) = = A + C + E - (B + D + F + G) = Deficit of $480.9Deficit of $480.9

Does it matter how the current Does it matter how the current account deficit is measured or account deficit is measured or

defined?defined? Yes! A truly accurate measure of the current account Yes! A truly accurate measure of the current account

balance must include the net flow of goods, services and balance must include the net flow of goods, services and transfers including gifts.transfers including gifts.

Considering only the difference between the value of Considering only the difference between the value of exports of goods and services and the value of imports of exports of goods and services and the value of imports of goods an services is representative of the trade balance goods an services is representative of the trade balance only.only.

Considering the difference between national (both public Considering the difference between national (both public and private) savings and investment is inaccurate because and private) savings and investment is inaccurate because it can misrepresent a low level of savings and a high level it can misrepresent a low level of savings and a high level of consumption for a high rate of investment.of consumption for a high rate of investment.

Measuring/defining the CA deficit in terms of the timing of Measuring/defining the CA deficit in terms of the timing of trade is faulty because timing is likely not the only reason trade is faulty because timing is likely not the only reason there is a current account deficit, except in extreme cases. there is a current account deficit, except in extreme cases.

What causes a current account What causes a current account deficit?deficit?

Real CausesReal Causes High consumptionHigh consumption Low SavingsLow Savings High investment High investment

(possibly a popular (possibly a popular cause)cause)

Competitiveness Competitiveness problemsproblems

Popular CausesPopular Causes Unfair trade Unfair trade

practicespractices Natural Natural

Disasters/CrisisDisasters/Crisis

Trends…Trends…

Capital-poor developing countries Capital-poor developing countries often have CA deficits often have CA deficits

Private capital flows from developing Private capital flows from developing to advanced economies leading to CA to advanced economies leading to CA deficits in advanced economies (U.S)deficits in advanced economies (U.S)

Developing countries and emerging Developing countries and emerging market economies usually run market economies usually run surplusessurpluses

https://www.cia.gov/cia/publications/fahttps://www.cia.gov/cia/publications/factbook/rankorder/2187rank.htmlctbook/rankorder/2187rank.html

Do current account deficits matter?Do current account deficits matter?

G & R say, “It all depends.”G & R say, “It all depends.” If the extent of external debt of a If the extent of external debt of a

nation is manageable and borrowing nation is manageable and borrowing will finance investment with a higher will finance investment with a higher marginal product then running a CA marginal product then running a CA deficit may not matter unless the CA deficit may not matter unless the CA deficit becomes unsustainable. deficit becomes unsustainable.

Do current account deficits matter?Do current account deficits matter?

CA deficits also matter when nations are faced with the CA deficits also matter when nations are faced with the following:following:

An overvalued real exchange rateAn overvalued real exchange rate Inadequate foreign exchange reservesInadequate foreign exchange reserves Fast domestic credit growthFast domestic credit growth Unfavorable terms of trade shocksUnfavorable terms of trade shocks Low growth in partner countriesLow growth in partner countries Higher interest rates in industrial countriesHigher interest rates in industrial countries Extent of liability dollarization and maturity mismatchesExtent of liability dollarization and maturity mismatches Relative stability of FDI vs. portfolio and short-term Relative stability of FDI vs. portfolio and short-term

investment flowsinvestment flows Weak financial sectors (that lead states to borrow from Weak financial sectors (that lead states to borrow from

abroad and loan domestically)abroad and loan domestically)

Case in point: Thailand in 1997 and the resulting economic Case in point: Thailand in 1997 and the resulting economic crisis. crisis.

Do current account deficits matter?Do current account deficits matter?

CA deficits are less likely to have a CA deficits are less likely to have a significant impact when nations are faced significant impact when nations are faced with:with:

A flexible exchange rate regimeA flexible exchange rate regime Higher degree of opennessHigher degree of openness Export diversificationExport diversification Financial sector developmentFinancial sector development Coherent fiscal and monetary policiesCoherent fiscal and monetary policies

Case in point: The United States?Case in point: The United States?

Bernanke on the US Current Bernanke on the US Current Account Deficit 2/14/07Account Deficit 2/14/07Source: http://money.cnn.com/2007/02/14/news/economy/bernanke_remarks/index.htm?postversion=2007021412Source: http://money.cnn.com/2007/02/14/news/economy/bernanke_remarks/index.htm?postversion=2007021412

On balance, import growth slowed in On balance, import growth slowed in 2006, to 3 percent. Economic growth 2006, to 3 percent. Economic growth abroad should support further steady abroad should support further steady growth in U.S. exports this year. growth in U.S. exports this year. Despite the improvements in trade Despite the improvements in trade performance, the U.S. current account performance, the U.S. current account deficit remains large, averaging about deficit remains large, averaging about 6-1/2 percent of nominal GDP during 6-1/2 percent of nominal GDP during the first three quarters of 2006 (the the first three quarters of 2006 (the latest available data). latest available data).

Alternative view of the Current Account Alternative view of the Current Account Deficit and the US EconomyDeficit and the US Economy

http://www.petersoninstitute.org/publications/papers/paper.cfm?Rhttp://www.petersoninstitute.org/publications/papers/paper.cfm?ResearchID=705esearchID=705

by C. Fred Bergsten, Peterson Instituteby C. Fred Bergsten, Peterson InstituteTestimony before the Budget Committee of the United States Testimony before the Budget Committee of the United States SenateSenateFebruary 1, 2007 February 1, 2007

  The US current account deficit reached $850–875 billion in 2006. The US current account deficit reached $850–875 billion in 2006. It has exceeded annual rates of $900 billion in a couple of recent It has exceeded annual rates of $900 billion in a couple of recent quarters, including the latest for which full data are available (the quarters, including the latest for which full data are available (the third quarter of 2006). It now accounts for about 7 percent of GDP, third quarter of 2006). It now accounts for about 7 percent of GDP, more than double the previous modern record of 3.4 percent in more than double the previous modern record of 3.4 percent in the middle 1980s (as a result of which the dollar dropped by 50 the middle 1980s (as a result of which the dollar dropped by 50 percent against the other major currencies over the three-year percent against the other major currencies over the three-year period 1985–87). period 1985–87).

Our external deficit has risen by an average of $100 billion Our external deficit has risen by an average of $100 billion annually over the past four years. It has climbed by an annual annually over the past four years. It has climbed by an annual average of $80 billion for the past nine years. The trajectory, as average of $80 billion for the past nine years. The trajectory, as well as the level of the imbalances, is clearly unsustainable. well as the level of the imbalances, is clearly unsustainable.

Alternative view continued…Alternative view continued… There are a few signs that the sharp and steady rise of the US current account deficit There are a few signs that the sharp and steady rise of the US current account deficit

may be leveling off. Excluding the impact of much higher prices for oil imports over may be leveling off. Excluding the impact of much higher prices for oil imports over the past year, the aggregate deficit is largely unchanged. Our trade imbalance with the past year, the aggregate deficit is largely unchanged. Our trade imbalance with Europe has declined modestly, due to a pickup in European growth and the lagged Europe has declined modestly, due to a pickup in European growth and the lagged effects of the substantial decline of the dollar against the euro in 2002–04. Our effects of the substantial decline of the dollar against the euro in 2002–04. Our exports have risen about twice as fast as our imports over the past couple of months exports have risen about twice as fast as our imports over the past couple of months for the first time since the late 1980s, after the sharp dollar fall of the previous three for the first time since the late 1980s, after the sharp dollar fall of the previous three years. (That currency adjustment, combined with the recession of 1990–91, virtually years. (That currency adjustment, combined with the recession of 1990–91, virtually eliminated our external deficits in the early 1990s.) eliminated our external deficits in the early 1990s.)

The Problem The Problem The huge and growing international trade and current account imbalances, centered The huge and growing international trade and current account imbalances, centered

on the US external deficits and net debtor position, represent the single greatest on the US external deficits and net debtor position, represent the single greatest threat to the continued prosperity and stability of the United States and world threat to the continued prosperity and stability of the United States and world economies. They could at any time trigger a large and rapid decline in the exchange economies. They could at any time trigger a large and rapid decline in the exchange rate of the dollar that would initiate sharp increases in US inflation and interest rates, rate of the dollar that would initiate sharp increases in US inflation and interest rates, bringing on stagflation at a minimum and quite possibly a deep recession. bringing on stagflation at a minimum and quite possibly a deep recession.

Even in the absence of such a crisis, continued failure to address the imbalances Even in the absence of such a crisis, continued failure to address the imbalances constructively will inevitably lead to a costly and perhaps wrenching adjustment of constructively will inevitably lead to a costly and perhaps wrenching adjustment of the US and world economies. They could also lead to a disruption of US trade policy, the US and world economies. They could also lead to a disruption of US trade policy, threatening the openness of the global trading system. threatening the openness of the global trading system.

The only effective US policy response to the problem, as its critical contribution to the The only effective US policy response to the problem, as its critical contribution to the needed global solution,needed global solution,11 is a conversion of our present (and especially prospective) is a conversion of our present (and especially prospective) budget deficits into modest surpluses à la 1998–2001. The possibility of a sharp budget deficits into modest surpluses à la 1998–2001. The possibility of a sharp dollar fall is in fact the greatest short-term risk now emanating from our budget dollar fall is in fact the greatest short-term risk now emanating from our budget deficits and provides the most compelling reason for urgent action on them. deficits and provides the most compelling reason for urgent action on them.

ConclusionsConclusions Many people mistakenly attribute current account Many people mistakenly attribute current account

deficits to unfair trade practices. deficits to unfair trade practices. Current account deficits have various causes Current account deficits have various causes

including: a low level of savings, high levels of including: a low level of savings, high levels of consumption, competitiveness problems and high consumption, competitiveness problems and high levels of investment.levels of investment.

Current account deficits cannot be reversed Current account deficits cannot be reversed through reverting to protectionism. through reverting to protectionism.

A CA deficit can significantly effect the economic A CA deficit can significantly effect the economic success or failure of a country depending on the success or failure of a country depending on the other economic factors at play.other economic factors at play.

Despite the fact that not everyone agrees, Despite the fact that not everyone agrees, Current Account Deficits do really matter!Current Account Deficits do really matter!

ImplicationsImplications

Current account deficits and Current account deficits and globalizationglobalization

Likelihood of future economic crisis Likelihood of future economic crisis due to current account deficits and due to current account deficits and globalizationglobalization

A final thought….A final thought….

If you were the President, how would If you were the President, how would you address the issue of ballooning you address the issue of ballooning current account deficits and still be current account deficits and still be electable?electable?