Saturday, January 08, 2005

The Great Current Account Debate

This post will be a work in progress.

These are, in my opinion, some of the most interesting recent contributions to the ongoing debate over the US current account deficit. At least, they are the papers that have helped me to understand the most. Most of them focus on, or at least heavily emphasize, the dramatic increase in the global capital market integration. For example, according to Lane and Milesi-Ferreti, during the past 20 years “The growth in international financial interdependence is striking: during this period, aggregate assets and liabilities tripled as a share of GDP, FDI assets and liabilities increased four-fold, portfolio equity assets and liabilities six-fold, and debt assets and liabilities 2 ½ times.”

That is, most countries now own a lot more assets overseas than they used to, and conversely foreigners own a lot more assets in most countries than before. This increase in asset cross-ownership adds an important factor to the typical current account story, because after all, current accounts are meant to measure the change in net foreign liabilities of a country.

Maurice Obstfeld: External Adjustment

This paper is 100% intuition, and Obstfeld does a great job at bringing some fairly esoteric models down to earth. He explains why the next wave of research in balance of payments analysis will have to take into account not just trade flows, but asset valuations.

Kenneth Rogoff and Maurice Obstfeld, The Unsustainable Current Account Position Revisited

This paper deals more directly with the current account deficit. Rogoff and Obstfeld show that the dollar has to fall, and fall a lot, in order to close the current account deficit. They also show that, despite the fact that dollar depreciation erodes the value of net foreign liabilities, in the end it’s the trade flows that have to adjust.

Philip R. Lane and Gian Maria Milesi-Ferretti: Financial Globalization and Exchange Rates

This paper has some interesting analysis of data on net foreign liabilities of developing and developed countries. They show who are the biggest net creditors (Switzerland) and debtors (Iceland, New Zealand) in the developed world, and they also consider the developing economies.

Cédric Tille: The Impact of Exchange Rate Movements on U.S. Foreign Debt

This is a great primer on the way in which exchange rates affect the external assets and liabilities of the US. A must read for anyone who wants to say anything about the US current account deficit.

Pierre-Olivier Gourinchas and Helene Rey: International Financial Adjustment

This paper has some interesting empirical results. They show that net foreign assets contain information about the future of the exchange rate. In particular, “deviations from trend of the ratio of net exports to net foreign assets contain information about future portfolio returns and, possibly, future exchange rate changes.”


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