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External Adjustment and the Global Crisis

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  • Lane, Philip R.
  • Milesi-Ferretti, Gian Maria

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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8546.

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Date of creation: Aug 2011
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Handle: RePEc:cpr:ceprdp:8546

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Keywords: current account adjustment; global crisis;

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