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

  • Caroline Freund
  • Frank Warnock

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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11823.

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Date of creation: Dec 2005
Date of revision:
Publication status: published as Current Account Deficits in Industrial Countries: The Bigger They Are, The Harder They Fall? , Caroline Freund, Frank Warnock. in G7 Current Account Imbalances: Sustainability and Adjustment , Clarida. 2007
Handle: RePEc:nbr:nberwo:11823
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  1. Guy Debelle & Gabriele Galati, 2007. "Current Account Adjustment and Capital Flows," Review of International Economics, Wiley Blackwell, vol. 15(5), pages 989-1013, November.
  2. Francis E. Warnock & Veronica C. Warnock, 2005. "International capital flows and U.S. interest rates," International Finance Discussion Papers 840, Board of Governors of the Federal Reserve System (U.S.).
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  5. 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.
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  10. Burger, John D. & Warnock, Francis E., 2007. "Foreign participation in local currency bond markets," Review of Financial Economics, Elsevier, vol. 16(3), pages 291-304.
  11. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange rates and financial fragility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 329-368.
  12. Freund, Caroline, 2005. "Current account adjustment in industrial countries," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1278-1298, December.
  13. 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 827, Board of Governors of the Federal Reserve System (U.S.).
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  15. C. Fred Bergsten & John Williamson (ed.), 2004. "Dollar Adjustment: How Far? Against What?," Peterson Institute Press: All Books, Peterson Institute for International Economics, number sr17.
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