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Current Account Deficits in Industrial Countries: The Bigger They Are, The Harder They Fall?

In: G7 Current Account Imbalances: Sustainability and Adjustment

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  • Caroline Freund
  • Frank Warnock

Abstract

There are a number of worrisome features of the U.S. current account deficit. In particular, its size and persistence, the extent to which it is financing consumption as opposed to investment, and the reliance on debt inflows raise concerns about the likelihood of a sharp adjustment. We examine episodes of current account adjustment in industrial countries to assess the validity of these concerns. Our main findings are (i) larger deficits take longer to adjust and are associated with significantly slower income growth (relative to trend) during the current account recovery than smaller deficits, (ii) consumption-driven current account deficits involve significantly larger depreciations than deficits financing investment, and (iii) there is little evidence that deficits in economies that run persistent deficits, have large net foreign debt positions, experience greater short-term capital flows, or are less open are accommodated by more extensive exchange rate adjustment or slower growth. Our findings are consistent with earlier work showing that, in general, current account adjustment tends to be associated with slow income growth and a real depreciation. Overall, our results support claims that the size of the current account deficit and the extent to which it is financing consumption matter for adjustment.

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  • Richard H. Clarida, 2007. "G7 Current Account Imbalances: Sustainability and Adjustment," NBER Books, National Bureau of Economic Research, Inc, number clar06-2.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 0130.

    Handle: RePEc:nbr:nberch:0130

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    1. John D. Burger & Francis E. Warnock, 2004. "Foreign participation in local-currency bond markets," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 794, Board of Governors of the Federal Reserve System (U.S.).
    2. Freund, Caroline, 2005. "Current account adjustment in industrial countries," Journal of International Money and Finance, Elsevier, Elsevier, vol. 24(8), pages 1278-1298, December.
    3. Barry Eichengreen & Muge Adalet, 2005. "Current Account Reversals: Always a Problem?," NBER Working Papers 11634, National Bureau of Economic Research, Inc.
    4. C. Fred Bergsten & John Williamson (ed.), 2004. "Dollar Adjustment: How Far? Against What?," Peterson Institute Press: All Books, Peterson Institute for International Economics, Peterson Institute for International Economics, number sr17, July.
    5. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc.
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    7. Maurice Obstfeld & Kenneth Rogoff, 2005. "The unsustainable U.S. current account position revisited," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Feb.
    8. Milesi-Ferretti, Gian Maria & Razin, Assaf, 1998. "Current Account Reversals and Currency Crises: Empirical Regularities," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1921, C.E.P.R. Discussion Papers.
    9. Jeffrey A. Frankel & Andrew K. Rose, 1996. "Currency crashes in emerging markets: an empirical treatment," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 534, Board of Governors of the Federal Reserve System (U.S.).
    10. Richard H. Clarida & Manuela Goretti & Mark P. Taylor, 2006. "Are There Thresholds of Current Account Adjustment in the G7?," NBER Working Papers 12193, National Bureau of Economic Research, Inc.
    11. Francis E. Warnock & Veronica C. Warnock, 2005. "International Capital Flows and U.S. Interest Rates," The Institute for International Integration Studies Discussion Paper Series, IIIS iiisdp103, IIIS.
    12. Sebastian Edwards, 2002. "Does the Current Account Matter?," NBER Chapters, in: Preventing Currency Crises in Emerging Markets, pages 21-76 National Bureau of Economic Research, Inc.
    13. Chinn, Menzie D. & Prasad, Eswar S., 2003. "Medium-term determinants of current accounts in industrial and developing countries: an empirical exploration," Journal of International Economics, Elsevier, Elsevier, vol. 59(1), pages 47-76, January.
    14. Hilary Croke & Steven B. Kamin & Sylvain Leduc, 2005. "Financial market developments and economic activity during current account adjustments in industrial economies," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 827, Board of Governors of the Federal Reserve System (U.S.).
    15. Caroline L. Freund, 2000. "Current account adjustment in industrialized countries," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 692, Board of Governors of the Federal Reserve System (U.S.).
    16. Francis E. Warnock & Veronica C. Warnock, 2005. "International capital flows and U.S. interest rates," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 840, Board of Governors of the Federal Reserve System (U.S.).
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