External Balance Adjustment: An Intra-National and International Comparison

Large external imbalances have become a policy concern. This study investigates the determinants of external balances for regions within a single country — Canadian provinces — as well as for a sample of 18 OECD countries. External balance adjustment may differ for provinces since there are few intranational barriers to the mobility of capital, goods and labour within Canada. Also, because Canada is a monetary union, there is no currency risk associated with lending and borrowing across provinces, and this may promote inter-provincial financial flows. The estimates show that the short run response of the external balance to disturbances, such as a deterioration in the terms of trade, is typically larger for Canadian provinces than for OECD countries. There is also a much greater speed of adjustment of the external balance in the Canadian provinces. This faster adjustment speed, combined with the larger response of the external balance, means that provinces may see a quicker resolution of external imbalances, but larger deficits or surpluses may emerge before adjustment occurs.