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Global Current Account Adjustments: A Decomposition

Listed author(s):
  • Michael B. Devereux


    (Department of Economics University of British Columbia)

  • Amartya Lahiri

In the last five years the international macroeconomics literature has become increasingly concerned with global current account imbalances, with particular focus on the size and persistence of the US current account deficit. While much of the recent literature on global imbalances (e.g. Caballero and Gourinchas 2005, Engel and Rogers, 2005 ) has attempted to rationalize the recent surge in the US current account deficit within theoretical settings, there has been little effort devoted to providing a quantitative accounting of the observed path of capital flows. In this paper we attempt to answer precisely this question. We follow the recent methodology developed by Cole and Ohanian (2004, 2005), Chari et al. (2004) etc. In particular, we construct a model of the world economy comprised of three regions – the US, EU/Japan and Emerging Markets. The model is the standard one-sector neoclassical growth model with production and investment. We then run actual data through the optimality conditions of the model and back out the ex-post deviations (or “wedges†) in these conditions relative to optimality. We call these measured deviations “wedges†. The model generates three wedges – two optimality wedges and one productivity wedge. We find that in order to rationalize the data, the neoclassical model demands a combination of time varying wedges in the intertemporal Euler wedge as well as variations in the productivity wedge. However, from a purely accounting standpoint, the productivity wedge is quantitatively much larger than the mean level of the Euler wedge during our sample period. This leads us to conclude that explanations such as Caballero-Gourinchas (2005), which imply time variation in the Euler wedge can at best, be a very partial explanation of the growing global imbalance. Explanations which center on productivity differences (like the older absorption view of current account determination) are quantitatively more important.

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 750.

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Date of creation: 03 Dec 2006
Handle: RePEc:red:sed006:750
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. Amartya Lahiri & Kei-Mu Yi, 2005. "A Tale of Two States," 2005 Meeting Papers 132, Society for Economic Dynamics.
  2. Ricardo J. Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2008. "An Equilibrium Model of "Global Imbalances" and Low Interest Rates," American Economic Review, American Economic Association, vol. 98(1), pages 358-393, March.
  3. Edward C. Prescott, 2004. "Why do Americans work so much more than Europeans?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Jul, pages 2-13.
  4. Harold L. Cole & Lee E. Ohanian, 2004. "New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis," Journal of Political Economy, University of Chicago Press, vol. 112(4), pages 779-816, August.
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