Chapter 2: Global Imbalances

Huge global imbalances have emerged as a result of the massive current account deficits of the US. The US deficit is largely matched by surpluses in Asia, oil-exporting countries and a few European countries. Correction of global imbalances will require substantial depreciation of the US dollar, though the extent of the adjustment cannot be precisely estimated. The correction of global imbalances could lead to a prolonged fall in the external demand for European products as well as to increased competition from US firms. A large enough fall of the dollar could cause substantial negative wealth shocks arising from reductions in the value of Europe’s dollar-denominated assets. The risk of a financial crisis will increase if a large fall in the dollar is accompanied by a drop in US and worldwide output. It would be difficult to deal with such a crisis under the current frameworks for monetary and fiscal policy. The sizeable government budget deficits in some large EU countries imply that fiscal policy may not enjoy the necessary room for manoeuvre in such a situation.