TABLE OF CONTENTS
Acknowledgment
Introduction - Richard H. Clarida
DOI: 10.7208/chicago/9780226107288.003.0001
[exchange rate, G7 current account imbalances, current account sustainability, capital account theory, adjustment, economic theory]
This book addresses the current account imbalances of the world's seven major industrialized countries. It is divided into three sections: origins of G7 current account imbalances; empirical studies of G7 current account and exchange rate adjustment; and theoretical perspectives on current account sustainability and adjustment. Part I provides a sophisticated and novel application of the venerable capital account theory of the current account. Part II concentrates on the possible empirical connection between the size of a current account imbalance and the way in which and the channels through which adjustment in that imbalance takes place. Finally, Part III uses economic theory and presents valuable and novel insights into the issues of current account sustainability and adjustment. An overview of the chapters included in this book is given. (pages 1 - 8)
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I. Origins of G7 Current Account Imbalances
From World Banker to World Venture Capitalist - Pierre-Olivier Gourinchas, Hélène Rey
DOI: 10.7208/chicago/9780226107288.003.0002
[external assets, gross liabilities, market value, United States, gross assets, Bretton Woods, fixed exchange rate, liquidity provider]
This chapter investigates the historical evolution of U.S. external assets and liabilities at market value since 1952. It shows strong evidence of a sizeable excess return of gross assets over gross liabilities. It also demonstrates that the United States tends to borrow short and lend long. It supports the notion that the United States enjoyed a significant premium on its gross assets relative to its liabilities and that this premium has been increasing since the collapse of the Bretton Woods fixed exchange rate system. The collapse of Bretton Woods has not deprived the United States of its fundamental role as world liquidity provider. It is found that depreciations are associated with significantly larger returns on gross assets and lower returns on gross liabilities. Furthermore, while the United States is still some ways away from making net payments on its mounting stock of net liabilities, that moment is approaching. (pages 11 - 66)
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A Global Perspective on External Positions - Philip R. Lane, Gian Maria Milesi-Ferretti
DOI: 10.7208/chicago/9780226107288.003.0003
[net foreign assets, industrial countries, external assets, liabilities, capital flows, dollar returns, foreign investment, United States]
This chapter explores the increased dispersion in net external positions in recent years, particularly among industrial countries. Return differentials between external assets and liabilities can potentially exert significant impacts on the dynamics of net foreign assets. There is some evidence that a shift in returns is connected with a subsequent change in the level of capital flows. The analysis of relative rates of return and capital flows reveals that U.S. residents have consistently earned higher returns on their assets than they pay out on their liabilities. It also shows that the real dollar returns on foreign investment in the United States have on average been negative over the past four years and even more so when expressed in the currencies of most foreign investor countries. Since 2000, capital flows to the United States have shifted toward fixed-rate (and low-yield) debt instruments and away from equities. (pages 67 - 102)
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Direct Investment, Rising Real Wages, and the Absorption of Excess Labor in the Periphery - Michael P. Dooley, David Folkerts-Landau, Peter Garber
DOI: 10.7208/chicago/9780226107288.003.0004
[currency, China, development strategy, trade, exchange rate, inflation policy, financial transactions, United States, financial assets, industrialization]
This chapter concentrates on the connection between the currency regime and the development strategy of rapidly growing Asian countries, especially China. It specifically argues that the expansion of the volume of trade in goods and services and the volume of two-way trade in financial assets is the backbone of a successful industrialization and development strategy. Analysis of government behavior implies that there is a trade-off between objectives for intertemporal trade, objectives for net international investment positions, and objectives for growth in gross trade in goods and financial instruments. The optimal exchange rate and inflation policy are derived conceptually from the exhaustible resource problem. China has more than adequate controls on domestic and international financial transactions. Central banks have raised interest rates more slowly than in the United States, if at all, and bond yields have remained stable, while yields fell in the United States. (pages 103 - 130)
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II. Empirical Studies of G7 Current Account and Exchange Rate
Adjustment
Current Account Deficits in Industrial Countries - Caroline Freund, Frank Warnock
DOI: 10.7208/chicago/9780226107288.003.0005
[current account adjustment, industrial countries, current account deficit, financing, income growth, fiscal balance, gross domestic product, exchange rate]
This chapter investigates the episodes of current account adjustment in industrial countries. The data support the claims that the size of the current account deficit and the extent to which it is financing consumption matter for adjustment. Larger deficits take longer to resolve and are linked with relatively slower income growth during recovery. There is no evidence that the growth in the fiscal balance influences gross domestic product (GDP) growth relative to long-run average. There is a strong inverse correlation between the extent of exchange rate adjustment and the slowdown in GDP growth. Financing does not significantly matter for the adjustment process, indicating that markets are efficient at intermediating funds. The status of the dollar as the reserve currency has crucial implications for adjustment. Deficits driven by investment growth are more benign in terms of exchange rate adjustment than deficits driven by consumption or fiscal spending. (pages 133 - 168)
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Are There Thresholds of Current Account Adjustment in the G7? - Richard H. Clarida, Manuela Goretti, Mark P. Taylor
DOI: 10.7208/chicago/9780226107288.003.0006
[nonlinear models, current account adjustment, G7, exchange rate, United States, Japan, Germany, current account deficit]
This chapter addresses the nonlinear models of current account adjustment for the G7 countries. For most of the G7 countries, significant evidence of threshold effects in current account adjustment is observed. Statistically significant increases in exchange rate volatility during current account deficit adjustment regimes for the United States, Japan, and Germany are found. Additionally, it shows that compared to other G7 countries, the United States over the sample exhibited relatively wide thresholds within which current account adjustment is absent and relatively slow speeds of adjustment once these thresholds, especially the deficit threshold, are crossed. The U.S. current account deficit is in part an endogenous, general equilibrium outcome of global financial and macroeconomic integration. Moreover, it identifies a tendency toward G7 exchange rate depreciation during current account deficit regimes and exchange rate appreciation during current account surplus regimes. (pages 169 - 204)
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Current Account Reversals - Muge Adalet, Barry Eichengreen
DOI: 10.7208/chicago/9780226107288.003.0007
[current account reversals, gold standard era, interwar period, Bretton Woods, current account deficit, exchange rate]
This chapter evaluates the frequency, magnitude, and effects of current account reversals in the gold standard era (1880–1914), the interwar period (1919–1939), Bretton Woods (1945–1970), and the post-Bretton Woods float (1972–1997). The results confirm that the gold standard era and the years since 1970 differed strikingly from one another: reversals were smaller, less frequent, and less disruptive in the gold standard period. It also shows that the reversals were relatively costly when a large current account deficit had been allowed to emerge and the real exchange rate was allowed to become significantly overvalued in the preceding period. The growth of the current account deficit in the 1880s led from a combination of domestic economic and political factors. Reversals were both less common and smaller in the Bretton Woods and pre-World War I gold standard eras. (pages 205 - 246)
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Understanding the U.S. Trade Deficit - Catherine L. Mann, Katharina Plück
DOI: 10.7208/chicago/9780226107288.003.0008
[elasticity, U.S. trade flows, expenditure, trade prices, commodity, capital goods, consumer goods]
This chapter reports new estimates for the elasticity of U.S. trade flows using bilateral, commodity-detailed trade data for thirty-one countries, using measures of expenditure and trade prices matched to commodity groups and including a commodity-and-country specific proxy for global supply-cum-variety. It is found that industrial and developing countries have different demand and relative price elasticities for the four commodity categories. Also, it illustrates that variety is a significant variable for the behavior of capital goods trade. Matched expenditure, matched prices, and variety play a key role in decreasing the asymmetry of estimated elasticities of trade with respect to economic activity. Short-run estimates of U.S. consumer goods imports with respect to matched economic activity exhibit very high cyclical elasticity. There are differences in demand elasticities for consumer goods and for other product categories. (pages 247 - 282)
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Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency? - Menzie Chinn, Jeffrey A. Frankel
DOI: 10.7208/chicago/9780226107288.003.0009
[dollar, international reserve currency, currency shares, euro, foreign central banks, current account deficit, international monetary system]
This chapter investigates whether the dollar might eventually follow the precedent of the pound and cede its status as leading international reserve currency. The link between currency shares and their determinants is nonlinear, but changes are felt only with a long lag. The sustainability of the U.S. current account deficit may depend on the continued willingness of foreign central banks to collect ever-greater quantities of U.S. assets. The euro soon after its debut came into wide use to denominate bonds. The euro is the number two international currency, and has rapidly gained acceptance. Euro enthusiasts endured some serious setbacks in 2005. Data indicate that dollar depreciation would be no free lunch: it could have consequences for the functioning of the international monetary system as profound as the loss of the dollar's preeminent international currency position, and along with it the exorbitant privilege of easily financing U.S. deficits. (pages 283 - 336)
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III. Theoretical Perspectives on Current Account Sustainability
and Adjustment
The Unsustainable U.S. Current Account Position Revisited - Maurice Obstfeld, Kenneth Rogoff
DOI: 10.7208/chicago/9780226107288.003.0010
[global equilibrium, U.S. current account deficit, gross domestic product, dollar, current account adjustment, labor, capital, exchange rate]
This chapter reveals that when one takes into account the global equilibrium ramifications of an unwinding of the U.S. current account deficit, currently running at nearly 6 percent of gross domestic product (GDP), the potential adjustment of the dollar becomes considerably larger than estimates from previous papers. U.S. current account adjustment entails a larger potential decline in the dollar. It is assumed that labor and capital cannot move freely across sectors in the short run. The model indicates that the U.S. nontraded-goods productivity boom could help explain the widening of the U.S. current account deficit. The exchange rate effects may be massive when U.S. current account adjustment comes. Moreover, further deepening of global capital markets may postpone the day of reckoning. (pages 339 - 376)
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Smooth Landing or Crash? - Hamid Faruqee, Douglas Laxton, Dirk Muir, Paolo A. Pesenti
DOI: 10.7208/chicago/9780226107288.003.0011
[simulation model, global current account adjustment, structural policies, current account imbalances, foreign asset, Europe, Japan, labor market reforms]
This chapter employs a sophisticated new open economy multicountry simulation model to examine different scenarios for global current account adjustment. The analysis indicates that competition-friendly structural policies could play a prominent role in reducing current account imbalances on a sustainable basis if they were linked with a sustained increase in growth and a permanent downward shift in the net foreign asset positions of Europe and Japan. Japan and the euro area are relatively stable in terms of adjustment. US fiscal consolidation would not be obtained without some short-run costs for output growth. Europe and Japan could meaningfully add to the multilateral adjustment process through stronger pursuit of growth-enhancing structural reforms that align with their own national interests. Labor market reforms alone might not significantly contribute to rebalancing. (pages 377 - 456)
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The Dot-Com Bubble, the Bush Deficits, and the U.S. Current Account - Aart Kraay, Jaume Ventura
DOI: 10.7208/chicago/9780226107288.003.0012
[bubbly firms, economy, U.S. government, U.S. stock market, global equity bubble, net foreign assets, international imbalances, current account deficit]
This chapter reports a novel theoretical model that connects present international imbalances and the bursting of the global equity bubble in 2000. Budget deficits constitute a welfare-improving policy response to the collapse of the bubble. They also constitute a beggar-thy-neighbor policy that is responsible for the collapse of the bubble. The presented model crudely but effectively encapsulates conventional views of the U.S. current account deficit. The U.S. government recognizes the beneficial role that bubbly firms play in the world economy. The appearance of a bubble in the U.S. stock market in the second half of the 1990s explains much of the decline in U.S. net foreign assets. The collapse of the stock market in 2000 was the result of a coordination failure or change in investor sentiment, and the rapid expansion of public debt since then served to displace inefficient investments in the same way that the bubble did. (pages 457 - 496)
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Contributors
Author Index
Subject Index
