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External Adjustment and the Global Crisis

  • Gian Maria Milesi-Ferretti

    (International Monetary Fund and CEPR)

  • Philip Lane


    (Trinity College Dublin, IIIS and CEPR)

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 precrisiscurrent 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 IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp369.

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Length: 51 pages
Date of creation: Aug 2011
Date of revision:
Handle: RePEc:iis:dispap:iiisdp369
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  1. Enrique G. Mendoza, 2010. "Sudden Stops, Financial Crises, and Leverage," American Economic Review, American Economic Association, vol. 100(5), pages 1941-66, December.
  2. 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.
  3. Philip R Lane & Gian Maria Milesi-Ferretti, 2011. "The Cross-Country Incidence of the Global Crisis," IMF Economic Review, Palgrave Macmillan, vol. 59(1), pages 77-110, April.
  4. Menzie D. Chinn & Hiro Ito, 2005. "Current Account Balances, Financial Development and Institutions: Assaying the World "Savings Glut"," NBER Working Papers 11761, National Bureau of Economic Research, Inc.
  5. 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.
  6. 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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  8. Philip R. Lane & Gian M Milesi-Ferretti, 2007. "Europe and Global Imbalances," IMF Working Papers 07/144, International Monetary Fund.
  9. 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.
  10. Gian M Milesi-Ferretti & Olivier J Blanchard, 2009. "Global Imbalances; In Midstream?," IMF Staff Position Notes 2009/29, International Monetary Fund.
  11. Barry Eichengreen & Muge Adalet, 2005. "Current Account Reversals: Always a Problem?," NBER Working Papers 11634, National Bureau of Economic Research, Inc.
  12. Gian-Maria Milesi-Ferretti & Cédric Tille, 2010. "The Great Retrenchment: International Capital Flows During the Global Financial Crisis," IHEID Working Papers 18-2010, Economics Section, The Graduate Institute of International Studies, revised 15 Sep 2010.
  13. 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.
  14. 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.
  15. Jaewoo Lee & Jonathan David Ostry & Alessandro Prati & Luca A Ricci & Gian M Milesi-Ferretti, 2008. "Exchange Rate Assessments; CGER Methodologies," IMF Occasional Papers 261, International Monetary Fund.
  16. Gianluca Benigno & Christoph Thoenissen, 2002. "Equilibrium exchange rates and supply-side performance," Bank of England working papers 156, Bank of England.
  17. Buti,Marco & Deroose,Servaas & Gaspar,Vitor & Martins,João Nogueira (ed.), 2010. "The Euro," Cambridge Books, Cambridge University Press, number 9789279098420, November.
  18. 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.
  19. Morten O. Ravn & Stephanie Schmitt-Grohe, 2004. "Deep Habits," 2004 Meeting Papers 208, Society for Economic Dynamics.
  20. Maurice Obstfeld & Kenneth S. Rogoff, 2005. "The unsustainable U.S. current account position revisited," Proceedings, Federal Reserve Bank of San Francisco, issue Feb.
  21. 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.
  22. Joseph E. Gagnon, 2011. "Current Account Imbalances Coming Back," Working Paper Series WP11-1, Peterson Institute for International Economics.
  23. 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.
  24. Richard H. Clarida, 2006. "G7 Current Account Imbalances: Sustainability and Adjustment," NBER Working Papers 12194, National Bureau of Economic Research, Inc.
  25. International Monetary Fund, 2010. "Fiscal Policy and the Current Account," IMF Working Papers 10/121, International Monetary Fund.
  26. 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.
  27. 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.
  28. Charles Engel & John H. Rogers, 2006. "The U.S. current account deficit and the expected share of world output," Working Paper Series 2006-38, Federal Reserve Bank of San Francisco.
  29. Gruber, Joseph W. & Kamin, Steven B., 2007. "Explaining the global pattern of current account imbalances," Journal of International Money and Finance, Elsevier, vol. 26(4), pages 500-522, June.
  30. Ruo Chen & Gian M Milesi-Ferretti & Thierry Tressel, 2012. "External Imbalances in the Euro Area," IMF Working Papers 12/236, International Monetary Fund.
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