Global Imbalances Warwick J. McKibbin Center for Applied Macroeconomic Analysis (CAMA) RSPAS Australian National University &The Lowy Institute for International Policy & The Brookings Institution Presentation at Oxford University, 16 May 2006

Based on Lee, McKibbin and Park (2006) “Transpacific Trade Imbalances: Causes and Cures” World Economy vol 29 McKibbin and Stoeckel (2005) The United States current account deficits and world markets Forthcoming paper with Jong-Wha Lee on “Global Imbalances” McKibbin (2006) “The Global Macroeconomic Consequences of a Demogrphic Transition” Asian Economic Papers, MIT Press

Overview What are the macroeconomic imbalances? Sources of current account imbalances Quantifying Possible policies and shocks that can affect current accounts The Role of Demographics Summary and Conclusion

Two Aspects of Global Imbalances Global Savings in excess of global investment which shows up as low long term real interest rates National savings and investment imbalances which show up as current account imbalances between countries –Countries with national savings greater than national investment run current account surpluses –Countries with national investment greater than national savings run current account deficits

Global Current accounts

Number of Real Factors and not a Single cause Pull –US fiscal deficits –Decline in household saving –Strong productivity growth Push –Decline in Asian investment rates (except China) –Rising corporate and household saving in China –Oil revenue recycling by Oil Exporters

Change in Asian Current accounts Large fall in Investment except China Rise in Chinese corporate and household savings

Implication of various shocks for Current accounts Using the G-Cubed (Asia Pacific Model)

Types of Structural Global Models

G-Cubed (Asia Pacific) Model Estimated dynamic intertemporal model with Keynesian short-run rigidities –Adjustment costs in capital accumulation –Financial capital mobile given risk premia –Wages adjust slowly given labour market rigidities –Financial markets for equity, bonds, money –Mix of intertemporal optimizing and rule of thumb decision rules –Imposition of intertemporal budget contraints

Countries United States Japan United Kingdom Europe CanadaAustralia New Zealand China India Korea Taiwan SingaporeHong Kong MalaysiaThailand Indonesia Philippines Oil Exporting Developing Countries Eastern Europe and the former Soviet Union Other Developing Countries

Sectors Energy Mining Agriculture Durable Manufacturing Non-Durable Manufacturing Services

Simulations Sustained fall in Asian Investment –rise in equity risk premia of 2% in Indonesia, 1% in non Japan/non China Asia; 0.5% in Japan; fall of 0.5% in China Permanent US fiscal expansion financed by debt –Rise of 4% of GDP fiscal deficit 1% of GDP on Goods/services 1% of GDP on labor 2% of GDP of income tax cuts Revaluation of East Asian Exchange Rates of 10% Fiscal Stimulus in non-Japan Asia –2% of GDP comprising 1% GDP goods/ services and 1% GDP on labor

Adjustment Story: Asian Investment Decline Rise in equity risk premium implies rate of return on capital must rise above other assets –Capital stock must fall to generate the higher return –Investment declines –Portfolio holders substitute out of equities into bonds (r falls), into housing (housing prices rise) and into foreign assets (capital outflow) –Real exchange rate depreciates and GDP falls raising exports and lowering imports –Consistent with excess savings relative to investment Current account improves

Source: G-Cubed Asia Pacific Model version 58n

Adjustment Story: US Fiscal Policy Basic Mundell-Fleming story except intertemporal overlay and asset adjustment Higher spending/lower taxes initially raises GDP but over time GDP falls as resources are extracted from the private sector to finance the fiscal deficit Partial Ricardian adjustment in Consumption but long term real interest rates rise to free up resources from the private sector to finance the deficit Net capital inflow which initially appreciates the US real exchange rate –Exports fall, imports rise

Adjustment Story: US Fiscal Policy Investment rises initially but then falls, private saving rises but total savings falls by more than investment –US Current account deteriorates High long term real interest rates lowers global investment improving Asian current accounts

Source: G-Cubed Asia Pacific Model version 58n

Adjustment Story: East Asia Revaluation Monetary policy regimes differ across countries Fixed exchange rates in China and Hong Kong Other countries follow a modified Henderson-McKibbin Rule with an additional weight on a desired nominal exchange rate relative to the $US –Shock is a change in the desired bilateral rate with the $US.

Adjustment Story: East Asia Revaluation Real exchange rate initially appreciates –Over time prices rise less quickly and the real exchange eventually returns to base –GDP in appreciating countries fall relative to base Chinese GDP falls relative to base by 4% in the first year –Exports less competitive but domestic slowdown reduces imports Trade balance worsens slightly –GDP in other countries ambiguous depending on competition with China and East Asia versus fall in Asian demand from trading partners –Overall impact on US/Asia trade balances is small

Source: G-Cubed Asia Pacific Model version 58n

Adjustment Story: Asian Fiscal Stimulus Similar story to US policy except partial exchange rate targeting in some countries causes larger rises in GDP in Asia Less impact on long term real interest rates because of economic size and less crowding out of foreign investment Capital flows in to finance the fiscal deficit Real exchange rate appreciation –Trade balance deteriorates

Source: G-Cubed Asia Pacific Model version 58n

Conclusions of first paper on causes Predominant contribution to the transpacific trade imbalance is US fiscal policy Weak Asian investment since the 97 Crisis also important for the Asian trade surpluses but less important for the transpacific balance US fiscal contraction and Asian fiscal expansion plus a recovery in Asian investment rates would have a significant impact on reducing each country’s overall trade position and would also reduce the Transpacific trade imbalance

Conclusions East Asia exchange rate revaluation has significant effects on slowing East Asia for a year but not in changing global trade balances The worsening in East Asian competitiveness plus weaker East Asian growth tends to offset each other in the spillover to other countries and have a minor impact on the relative saving and investment balances across the region.

Additional Simulations – what else might happen? (based on McKibbin and Stoeckel (2005) Rise in US Household savings due to an exogenous fall in consumption (1% of GDP) Fall in US fiscal deficit to balance over 4 years Investor confidence in Asia Restored Stronger growth in China due to higher TFP (1% per year for 10 years) Stronger growth in Europe due to higher TFP (1% per year for 10 years)

Is there a demographic story behind the imbalances?

The Global Macroeconomic Consequences of a Demographic Transition Warwick J McKibbin Centre for Applied Macroeconomic Analysis, RSPAS, ANU; Lowy Institute for International Policy, Sydney The Brookings Institution, Washington DC; Prepared for a seminar at the Bank of Korea, Seoul Wednesday May

Figure 12: Contribution to Current Accounts of Own versus Global Demographic Change

Overall Conclusion US current account deficit and corresponding current account surpluses in other countries caused by a variety of factors that affect –Savings and investment changes in the United States China, East Asia and rest of world Exchange rate policy has little to do with changing current account balances which reflect real rather than monetary factors –This is unlikely to be a solution (especially for China) because it has minor effect on US savings and investment

Background Papers