This issue of IMF Staff Papers presents five papers from the conference on “Current Account Sustainability in Major Advanced Economies” held at the University of Wisconsin on May 2–3, 2008. The conference was organized by Charles Engel and Menzie Chinn, sponsored by the Center for World Affairs and the Global Economy and the Robert M. La Follette School of Public Affairs, and cosponsored by the Department of Economics, the European Union Center of Excellence, and the Center for International Business Education and Research.
Engel and John H. Rogers challenge the traditional intertemporal approach to the current account by studying direct observations on the expectations drawn from a survey of forecasters. With these expectations data, the authors extend previous work dispensing with the assumption of unbiased expectations (sometimes termed the rational expectations hypothesis). They find that expected national consumption growth rates are driven largely by expected national income growth rather than world consumption growth or world real interest rates. These results cast additional doubt on models built assuming free trade in assets driven by consumption-growth differences.
Suparna Chakraborty and Robert Dekle develop a model to study the roles of productivity differentials and financial frictions in the recent evolution of the U.S. current account deficit. They show that productivity differentials alone cannot explain the deficit because higher productivity growth in the rest of the world would have induced capital outflow from the United States, and would have narrowed the current account deficit. They show, however, that the lower cost of acquiring the U.S. assets abroad can explain the recent current account pattern.
Carol C. Bertaut, Steven B. Kamin, and Charles P. Thomas present a model-based evolution of the U.S. external position. They show that while the U.S. current account deficit will continue to expand, it will likely take many years before the size of its external debt poses a threat to the United States’ ability to obtain financing from foreign investors. They also find little evidence that countries’ indebtedness prompts abrupt changes in asset prices and exchange rates to correct current account positions. While their findings suggest that adjustment of the U.S. current account is not imminent, they also warn that factors excluded from the model could trigger adjustment sooner than predicted in their model.
Marcel Fratzscher and Roland Straub study the effect of asset price movements on current accounts in structural vector autoregressive models. They find that a 10 percent equity price increase in the United States relative to the rest of the world will worsen the U.S trade balances by 0.9 percent of GDP after 16 quarters, although the effect is different among G-7 countries. They attribute these differences to cross-country differences in equity-driven wealth effects on consumption.
Finally, Hamid Faruqee and Jaewoo Lee document the changes in the cross-country distribution of external positions. They find that the global dispersion of the current-account-to-GDP ratio is steadily increasing as trade and financial integration progress. However, they also find that the recent substantial expansion of the U.S. current account deficit—at the center of so-called “global imbalances”—cannot be explained as a trend phenomenon.
While each paper has its own focus, all papers have the common theme that current account sustainability is linked tightly to asset market developments. Instead of explaining current account deficits based on capital account surpluses or vice-versa, the papers provide explanations for current account and capital account dynamics in an integrated fashion. It is impossible to fully understand current account developments without looking at asset market developments. It is not an accident that these papers studying current account sustainability are published in this issue of IMF Staff Papers, as the International Monetary Fund continuously monitors balance of payment situations worldwide.
Finally, I want to state that it is quite an honor for me to be a guest editor of a special section of IMF Staff Papers publishing such excellent papers presented at a conference whose organizers, Charles Engel and Menzie Chinn, are my mentors.