Current account imbalances Doomsday or soft landing?

Literature *Blanchard, O (2006), “Current account deficits in rich countries,” IMF speaker’s series“Current account deficits in rich countries,” IMF speaker’s series Ricardo Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas, “An equilibrium model of global imbalances and low interest rates,” January MIT working paper Dooley, M., D. Folkerts-Landau and P. Garber (2004a) The Revived Bretton Woods System: The Effects of Periphery Intervention and Reserve Management on Interest Rates & Exchange Rates in Center Countries NBER Working Paper No , March. Engel and Rogers, 2006, “The US current account deficit and the expected share of world output,” NBER Working Paper No “The US current account deficit and the expected share of world output,” NBER Working Paper No *Bernanke, Ben [2005], “The Global Saving Glut and the U.S. Current Account Deficit,” available at Obstfeld, Maurice [2004], “External Adjustment”, unpublished manuscript, University of California at Berkeley. *Obstfeld, Maurice and Kenneth Rogoff [2005], “The Unsustainable US Current Account Position Revisited,” November Backus, David and Frederic Lambert [2005], “Current Account: Fact and Fiction,” unpublished manuscript, New York University. Gourinchas Pierre-Olivier and Helen Rey [2003] “The International Financial Adjustment, ” unpublished manuscript, Princeton University. Lane Philip and Gian Maria Milesi-Ferretti [2004] “The External Wealth of Nations: Measures of Foreign Assets and Liabilities for Industrial and Developing Nations,” Journal of International Economics 55, Roubini Nouriel and Brad Sester (2005), “Will the Bretton Woods Regime 2 Unravel Soon? The risk of a hard landing in ,” unpublished manuscript, the Symposium by the Federal Reserve Bank of San Francisco and UC Berkeley, San Francisco, February 4th, 2005.

Current account deficits in rich countries Over the past 20 years, current account deficits have increased in rich countries These deficits reflect private saving- investment decisions Are these deficits too large? What kind of adjustments are needed?

Causes of current account imbalances US based –trade deficit lost competitiveness high demand for imported goods –low savings, high consumption pattern wealth effect: stock market bubble, housing market boom –unusually high fiscal deficits due to Bush tax cut, and the war on terror

Causes of current account imbalances Saving glut (Ben Bernanke) Europe based –aging population (high savings) –lack of investment opportunities due to high capital to labor ratio Emerging economies and oil exporters –export driven model of development –lack of investment opportunities at home

Global adjustments Steady state (Bretton Woods II) (Dooley, Folkerts-Landau and Garber (2004) Hard lending or doomsday scenario (Roubini and Sester) Slow to moderate adjustment (Obstfeld and Rogoff)

Bretton Woods II Asian countries finance US CA deficit –Major developing currencies pegged to US dollar –export driven development –relocation of labor from rural China and India to tradable sector Europe does not play major role US absorbs savings of the rest of the world

Doomsday scenario Nouriel Roubini and Brad Sester Emerging market CBs stop buying US assets (Central banks financed 90% of the United States’ $530 billion current account deficit in 2003) Housing market crush in US leads to loss of wealth by households and increase savings risk a disorderly unraveling of the Bretton Woods 2 system: –sharp correction of the US dollar and of the US bond market –surge in US long-term interest rates –sharp fall in the price of a wide variety of risky assets (such a equities, housing, high-yield bonds, and emerging market sovereign debt) sharp economic slowdown in the US. It will force countries that now depend on US demand growth for their growth to adjust as well.

Unsustainable US current account position revisited Obstfeld and Rogoff 2005 –two country model of the world economy –θ is the (constant) elasticity of substitution between tradable and nontradable goods –η is the (constant) elasticity of substitution between domestically-producedand imported tradables

Savings glut Bernanke –too high savings in the rest of the world –US plays the role of vacuum cleaner and absorb the excess savings –Need for more investment and consumption in the emerging economies

Role of governments Blanchard –Taken the current imbalances as given, does it reflect market imperfections or it is optimal behavior of the households? high saving in China reflects in part the lack of retirement and health insurance low investment in parts of Asia reflects poor financial intermediation Low saving in the United States reflects in part public dissaving; private saving itself maybe based on incorrect expectations about retirement benefits and health care –Reducing these distortions, or in the last case, reducing the scale of deficit, is clearly desirable

Current situation: mixed signals Doomsday scenario has not materialized US dollar depreciate against all major currencies Trade balance, however, does not respond to dollar depreciation Housing market in US is slowing down Interest rate is low