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United States current account deficits: A stochastic optimal control analysis

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  • Stein, Jerome L.

Abstract

The "Pessimists" and the "Optimists" disagree whether the US external deficits and the associated buildup of US net foreign liabilities are problems that require urgent attention. A warning signal should be that the debt ratio deviates significantly from the optimal ratio. The optimal debt ratio or debt burden should take into account the vulnerability of consumption to shocks from the productivity of capital, the interest rate and exchange rate. The optimal debt ratio is derived from inter-temporal optimization using Dynamic Programming, because the shocks are unpredictable, and it is essential to have a feedback control mechanism. The optimal ratio depends upon the risk adjusted net return and risk aversion both at home and abroad. On the basis of alternative estimates, we conclude that the Pessimists' fears are justified on the basis of trends. The trend of the actual debt ratio is higher than that of the optimal ratio. The Optimists are correct that the current debt ratio is not a menace, because the current level of the debt ratio is not above the corresponding level of the optimum ratio.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 31 (2007)
Issue (Month): 5 (May)
Pages: 1321-1350

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Handle: RePEc:eee:jbfina:v:31:y:2007:i:5:p:1321-1350

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References

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  1. Jerome L. Stein, 2005. "Optimal Debt And Endogenous Growth In Models Of International Finance," Australian Economic Papers, Wiley Blackwell, vol. 44(4), pages 389-413, December.
  2. Fleming, Wendell H. & Stein, Jerome L., 2004. "Stochastic optimal control, international finance and debt," Journal of Banking & Finance, Elsevier, vol. 28(5), pages 979-996, May.
  3. Stein, Jerome L., 2006. "Stochastic Optimal Control, International Finance, and Debt Crises," OUP Catalogue, Oxford University Press, number 9780199280575, September.
  4. Richard N. Cooper, 2005. "Living with Global Imbalances: A Contrarian View," Policy Briefs PB05-03, Peterson Institute for International Economics.
  5. Wendell H. Fleming, 2005. "Optimal Investment Models With Minimum Consumption Criteria," Australian Economic Papers, Wiley Blackwell, vol. 44(4), pages 307-321, December.
  6. Eckhard Platen, 2005. "On the Role of the Growth Optimal Portfolio in Finance," Research Paper Series 144, Quantitative Finance Research Centre, University of Technology, Sydney.
  7. Catherine L. Mann, 1999. "Is the U.S. Trade Deficit Sustainable?," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 47, 1st quart.
  8. Edwin M. Truman, 2005. "Postponing Global Adjustment: An Analysis of the Pending Adjustment of Global Imbalances," Working Paper Series WP05-6, Peterson Institute for International Economics.
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Cited by:
  1. De Grauwe, Paul & Rovira Kaltwasser, Pablo, 2006. "A behavioural finance model of the exchange rate with many forecasting rules," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/103684, Katholieke Universiteit Leuven.
  2. Hiraguchi, Ryoji, 2009. "Non-concavity problems in the dynamic macroeconomic models: A note," Journal of Banking & Finance, Elsevier, vol. 33(3), pages 568-572, March.
  3. Stein, Jerome L., 2009. "A tale of two debt crises: a stochastic optimal control analysis," Economics Discussion Papers 2009-44, Kiel Institute for the World Economy.

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