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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
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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. Gabriele Galati & Guy Debelle, 2005. "Current account adjustment and capital flows," BIS Working Papers 169, Bank for International Settlements.
  2. Sebastian Edwards, 2001. "Does the Current Account Matter?," NBER Working Papers 8275, National Bureau of Economic Research, Inc.
  3. Caroline L. Freund, 2000. "Current account adjustment in industrialized countries," International Finance Discussion Papers 692, Board of Governors of the Federal Reserve System (U.S.).
  4. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc.
  5. Muge Adalet & Barry Eichengreen, 2007. "Current Account Reversals: Always a Problem?," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 205-246 National Bureau of Economic Research, Inc.
  6. Maurice Obstfeld & Kenneth Rogoff, 2005. "The unsustainable U.S. current account position revisited," Proceedings, Federal Reserve Bank of San Francisco, issue Feb.
  7. 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.
  8. Menzie David Chinn & Eswar Prasad, 2000. "Medium-Term Determinants of Current Accounts in Industrial and Developing Countries; An Empirical Exploration," IMF Working Papers 00/46, International Monetary Fund.
  9. Francis E. Warnock & Veronica Cacdac Warnock, 2006. "International Capital Flows and U.S. Interest Rates," NBER Working Papers 12560, National Bureau of Economic Research, Inc.
  10. Richard H. Clarida & Manuela Goretti & Mark P. Taylor, 2007. "Are There Thresholds of Current Account Adjustment in the G7?," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 169-204 National Bureau of Economic Research, Inc.
  11. Gian-Maria Milesi-Ferretti & Assaf Razin, 1998. "Current Account Reversals and Currency Crisis; Empirical Regularities," IMF Working Papers 98/89, International Monetary Fund.
  12. Jeffrey A. Frankel & Andrew K. Rose, 1996. "Currency crashes in emerging markets: an empirical treatment," International Finance Discussion Papers 534, Board of Governors of the Federal Reserve System (U.S.).
  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.).
  14. Freund, Caroline, 2005. "Current account adjustment in industrial countries," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1278-1298, December.
  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, May.
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