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External Adjustment and the Global Crisis

In: Global Financial Crisis

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  • Philip R. Lane
  • Gian Maria Milesi-Ferretti

Abstract

The period preceding the global financial crisis was characterized by a substantial widening of current account imbalances across the world. Since the onset of the crisis, these imbalances have contracted to a significant extent. In this paper, we analyze the ongoing process of external adjustment in advanced economies and emerging markets. We find that countries whose pre- crisis current account balances were in excess of what could be explained by standard economic fundamentals have experienced the largest contractions in their external balance. We subsequently examine the contributions of real exchange rates, domestic demand and domestic output to the adjustment process (allowing for differences across exchange rate regimes) and find that external adjustment in deficit countries was achieved primarily through demand compression, rather than expenditure switching. Finally, we show that other investment flows was the main adjustment category in the financial account but that ECB liquidity and official external assistance have cushioned the exit of private capital flows for some countries.

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This chapter was published in:

  • Charles Engel & Kristin Forbes & Jeffrey Frankel, 2012. "Global Financial Crisis," NBER Books, National Bureau of Economic Research, Inc, number enge11-2, January.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 13169.

    Handle: RePEc:nbr:nberch:13169

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    References

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    1. Ali Abbas, S.M. & Bouhga-Hagbe, Jacques & Fatás, Antonio & Mauro, Paolo & Velloso, Ricardo C., 2010. "Fiscal Policy and the Current Account," CEPR Discussion Papers 7859, C.E.P.R. Discussion Papers.
    2. Chinn, Menzie David & Wei, Shang-Jin, 2008. "A Faith-based Initiative: Does a Flexible Exchange Rate Regime Really Facilitate Current Account Adjustment?," CEPR Discussion Papers 7076, C.E.P.R. Discussion Papers.
    3. Philip R. Lane & Gian Maria Milesi-Ferretti, 2007. "Europe and global imbalances," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 22, pages 519-573, 07.
    4. Maurice Obstfeld & Kenneth Rogoff, 2007. "The Unsustainable U.S. Current Account Position Revisited," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 339-376 National Bureau of Economic Research, Inc.
    5. Bénétrix, Agustín & Lane, Philip R., 2010. "International Differences in Fiscal Policy During the Global Crisis," CEPR Discussion Papers 8009, C.E.P.R. Discussion Papers.
    6. Gian‐Maria Milesi‐Ferretti & Cédric Tille, 2011. "The great retrenchment: international capital flows during the global financial crisis," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 26(66), pages 285-342, 04.
    7. Morten O. Ravn & Stephanie Schmitt-Grohe, 2004. "Deep Habits," 2004 Meeting Papers 208, Society for Economic Dynamics.
    8. 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, vol. 59(1), pages 47-76, January.
    9. Barry Eichengreen & Muge Adalet, 2005. "Current Account Reversals: Always a Problem?," NBER Working Papers 11634, National Bureau of Economic Research, Inc.
    10. Caroline Freund & Frank Warnock, 2007. "Current Account Deficits in Industrial Countries: The Bigger They Are, The Harder They Fall?," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 133-168 National Bureau of Economic Research, Inc.
    11. Charles Engel & John H. Rogers, 2006. "The U.S. Current Account Deficit and the Expected Share of World Output," NBER Working Papers 11921, National Bureau of Economic Research, Inc.
    12. Philip Lane & Gian Maria Milesi-Ferretti, 2001. "Long-Term Capital Movements," CEG Working Papers, Trinity College Dublin, Department of Economics 20018, Trinity College Dublin, Department of Economics.
      • Philip R. Lane & Gian Maria Milesi-Ferretti, 2002. "Long-Term Capital Movements," NBER Chapters, in: NBER Macroeconomics Annual 2001, Volume 16, pages 73-136 National Bureau of Economic Research, Inc.
    13. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1992. "Dynamics of the trade balance and the terms of trade: the S-curve," Working Paper 9211, Federal Reserve Bank of Cleveland.
    14. Gian Maria Milesi-Ferrett & Assaf Razin, 1998. "Current Account Reversals and Currency Crises: Empirical Regularities," NBER Working Papers 6620, National Bureau of Economic Research, Inc.
    15. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2010. "The Cross-Country Incidence of the Global Crisis," CEPR Discussion Papers 7954, C.E.P.R. Discussion Papers.
    16. Chinn, Menzie D. & Ito, Hiro, 2007. "Current account balances, financial development and institutions: Assaying the world "saving glut"," Journal of International Money and Finance, Elsevier, Elsevier, vol. 26(4), pages 546-569, June.
    17. Enrique G. Mendoza, 2010. "Sudden Stops, Financial Crises, and Leverage," American Economic Review, American Economic Association, vol. 100(5), pages 1941-66, December.
    18. Aizenman, Joshua & Jinjarak, Yothin, 2008. "Current account patterns and national real estate markets," Santa Cruz Department of Economics, Working Paper Series qt1rh4s127, Department of Economics, UC Santa Cruz.
    19. Atish R. Ghosh & Jonathan David Ostry & Charalambos G. Tsangarides, 2011. "Exchange Rate Regimes and the Stability of the International Monetary System," IMF Occasional Papers 270, International Monetary Fund.
    20. Forbes, Kristin J. & Warnock, Francis E., 2012. "Capital flow waves: Surges, stops, flight, and retrenchment," Journal of International Economics, Elsevier, vol. 88(2), pages 235-251.
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    24. Olivier J. Blanchard & Mitali Das & Hamid Faruqee, 2010. "The Initial Impact of the Crisis on Emerging Market Countries," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 41(1 (Spring), pages 263-323.
    25. Gianluca Benigno & Christoph Thoenissen, 2003. "Equilibrium Exchange Rates and Supply-Side Performance," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 113(486), pages C103-C124, March.
    26. Blanchard, Olivier J & Milesi-Ferretti, Gian Maria, 2010. "Global Imbalances: In Midstream?," CEPR Discussion Papers 7693, C.E.P.R. Discussion Papers.
    27. Joseph E. Gagnon, 2011. "Current Account Imbalances Coming Back," Working Paper Series, Peterson Institute for International Economics WP11-1, Peterson Institute for International Economics.
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