This Selected Issues paper analyzes the condition of household, corporate, and bank balance sheets; sustainability of the U.S. external current account deficit; the impact of a slowdown in the growth on the euro area economy; and the implications of the reduction in U.S. treasury securities for monetary policy and financial markets. The study discusses the pros and cons of investing government assets in private securities; the recent changes in agricultural support policy and their impact on other countries; technological innovations and the adoption of new technologies.

Abstract

This Selected Issues paper analyzes the condition of household, corporate, and bank balance sheets; sustainability of the U.S. external current account deficit; the impact of a slowdown in the growth on the euro area economy; and the implications of the reduction in U.S. treasury securities for monetary policy and financial markets. The study discusses the pros and cons of investing government assets in private securities; the recent changes in agricultural support policy and their impact on other countries; technological innovations and the adoption of new technologies.

II. Sustainability of the U.S. External Current Account Deficit1

1. The rise in the U.S. external current account deficit to unprecedented levels in recent years has raised doubts about its sustainability and concerns regarding the impact that a rapid and disorderly correction of this imbalance might have. The deficit rose from 1½ percent of GDP in 1995 to 4½ percent ($445 billion) in 2000, compared with its average during the previous two decades of 1½ percent. The financing of the deficit in 2000 absorbed an estimated 7¾ percent of the savings of the rest of the world, in contrast to the 2½ percent absorbed on average during most of the last two decades.

2. A number of observers have argued that such high levels of the deficit cannot persist for very long.2 They argue that if such deficits were to continue for an extended period, U.S. external liabilities would rise to an unprecedented level, and U.S. dollar assets would represent a growing portion of world portfolios that foreign investors would be increasingly less willing to hold. This situation would run the risk of large or possibly sharp adjustments in the current account and the external value of the dollar. Such abrupt adjustments could potentially lead to substantial dislocations in the global economy and disruptions in U.S. and world financial markets.

3. Rapid U.S. GDP growth and relatively weaker growth in other parts of the world, notably Europe and Japan, contributed to the rise in the deficit. Inflows also have risen rapidly during periods of global financial stress, when the demand for dollar assets as a “safe haven” has increased. More importantly, however, there has been a surge in capital inflows seeking higher risk-adjusted real returns in the United States. Higher U.S. real returns have been related to the pickup in U.S. productivity growth since the mid-1990s. The surge in capital inflows since the mid-1990s has included, in addition to direct investment inflows, a substantial increase in portfolio inflows, of which a large share has come from the euro area (Figure 1).

Figure 1.
Figure 1.

United States: Global Net Portfolio Inflows by Asset Class

(Billions of US$)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A002

Source: U.S. Treasury International Capital Reporting System.

4. Over the medium term, adjustment in the U.S. current account imbalance would take place if output and income growth in the United States and the other major industrial countries converge. In addition, a depreciation of the U.S. dollar in real terms is expected to contribute to the adjustment process. Such a depreciation may result from movements in relative prices if U.S. traded goods prices tend to rise more slowly than competitors’ prices. It may also come from a nominal depreciation of the dollar. At this juncture, whether there may be a large nominal decline in the dollar appears to depend significantly on expected real returns on U.S. assets, which would reflect expectations regarding the relative performance of U S productivity growth The paper dicusses scenarios derived from the IMF’s multi-country model (MULTIMOD) based on alternative patterns of relative productivity growth. If U.S. productivity growth were to continue to substantially exceed that in other major countries, large deficits in the current account could persist for some time. Conversely, if the productivity growth gap were to narrow quickly, the nominal value of the dollar and the U.S. external imbalance could adjust rapidly.

5. Concerns regarding the long-term viability of the U.S. current account balance center on whether there exist underlying structural problems that could prevent the external balance from achieving a sustainable level. In particular, attention has been focused on the difference in estimated income elasticities of U.S. exports and imports, and the implication that this difference would perpetuate a large current account deficit in the absence of sharp and sustained declines in the real value of the dollar. However, historically, there has been no long-term trend in the real value of the dollar. This is because the difference in the estimated income elasticities for exports and imports has been offset by a tendency for U.S. incomes to grow more slowly than foreign incomes Moreover, estimates of income elasticities for U S Sports and imports for periods ending in the 1990s demonstrate that these elasticities appear to be converging as U.S and foreign income growth has likewise converged.

6. Assuming that income growth in the United States and the rest of the world and income elasticities for U.S. exports and imports converge, MULTIMOD scenarios suggest that the current account deficit would decline over the longer term to around ½ percent of GDP on average (equivalent to 1 percent of rest of the world savings, a level in line with historical experience), provided the United States continues to follow prudent macroeconomic policies. The scenarios also illustrate that a higher level of national income and a more favorable external position could be achieved if the United States were to move more aggressively in the near term and run larger fiscal surpluses as a means of pre-funding part of its future liabilities associated with the aging of the population. This could be achieved by adopting as a long-term fiscal objective measures to eliminate the actuarial imbalances in the Social Security and Medicare programs and keeping the rest of the budget in balance over the economic cycle.

A. Medium-Term Adjustment

7. Over the medium term, the U.S. current account deficit is expected to narrow. Whether the adjustment in the deficit is a smooth or abrupt process is a key concern. Indeed, some observers argue that the risks arise not so much from the size of the deficit, or the outstanding U.S. net liability position, as from the suddenness of any adjustment.3 The experience of recent decades suggests that, during periods of current account adjustment, movements in the external balance have typically been gradual and have been associated with relatively smooth adjustments in the real value of the dollar (Figure 2) An exception was the substantial fall in the real value of the dollar and the current account adjustment that took place during the latter half of the 1980s. The adjustment was, however, spread out over a period of more than three years and, moreover, the period was characterized by very loose fiscal policy and the expectation that significant budget deficits would continue. The current fiscal environment is substantially different, with the prospect of continuing fiscal surpluses.

Figure 2.
Figure 2.

United States: GDP Growth, Current Account Balance, and Nominal and Real Effective Exchange Rate

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A002

Sources: U.S. Bureau of Economic Analysis; and IMF-WEO estimates.

8. Over time, the relative growth performance between the United States and other countries may shift, with other countries growing relatively faster as the information-technology-driven gains in productivity of recent years spread more rapidly beyond the United States. Higher investment in information technology by other countries would boost U.S. exports, since the United States is a major supplier of this equipment. A cyclical slowing in U.S. activity relative to other countries would moderate U.S. import growth. These developments would tend to foster adjustment in the U.S. external balance.

9. Depreciation in the real value of the dollar is likely to bear the brunt of the adjustment in the external deficit, with the change coming through some combination of movements in relative prices and the nominal exchange rate. A slower rate of increase in U.S. export prices relative to competitors’ prices, possibly as a result of relative gains in productivity reducing U.S. costs, would contribute toward a depreciation of the real exchange rate. At the same time, the nominal value of the dollar could depreciate over time if capital flows to the United States diminish. The speed and extent of the depreciation would be influenced by the evolution of relative productivity gains in the United States and partner countries and its implications for the pattern of net capital flows.

10. Insofar as the current account deficit and the strong value of the dollar have been largely supported by productivity improvements in the United States relative to other countries, a reversal in this factor could induce rapid external adjustment. Buoyant equity prices and capital spending in the United States have in some measure been predicated on expectations of continued strong productivity growth. A weaker outturn in productivity—at least relative to partner countries—could lower comparative rates of return, reduce the level of capital inflows, and narrow the current account deficit. As with the dollar, the nature of the adjustment in the current account could depend significantly on the rapidity of these developments. Prolonged productivity gains in the United States would be supportive of the external deficit and the value of the dollar. But relatively rapid gains in partner countries (especially if coupled with some slowdown in the United States) could induce a sharp adjustment in the dollar and the current account balance.

11. To address these questions, the staff conducted two alternative “productivity” scenarios using MULTIMOD (Table 1). In the first scenario, a positive productivity shock prolongs relative gains in the United States before catch-up in the rest of the world gradually takes place. The shock contains two components: a temporary increase in total factor productivity (TFP) growth and a temporary increase in the market value of capital.4 Together, the effects of this shock replicate qualitatively many aspects of the U.S. economy in recent years. GDP growth rises persistently above baseline; investment is the demand component that reacts most strongly, rising as a share of GDP; consumption spending also rises as private saving rates decline (albeit slightly). Meanwhile, the dollar appreciates in the near term, and the current account moves into deficit for a sustained period relative to its baseline level.

Table 1.

United States: MULTIMOD Scenario

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12. In the second scenario, partner countries are assumed to catch up to U.S. productivity levels relatively quickly.5 In this case, the relative gains abroad contribute to a sharp depreciation of the dollar and a rapid reduction in the U.S. current account deficit. The output loss, dollar depreciation, and narrowing of the current account deficit would be more severe if the United States were also to experience a slowdown in productivity growth.

B. Long-Term Outlook

13. In some quarters, concern about adjustment in the current account deficit stems from the size of the deficit and an expectation that it would persist in the absence of a large real depreciation of the dollar, owing to a significant difference in the income elasticities of U.S. imports and exports. For most of the past several decades, the income elasticity of U.S. imports has exceeded that of U.S. exports by a wide margin.6 (Some other countries, notably Japan, have had the opposite pattern.) Empirically, however, the difference between a country’s import and export income elasticities seems to be indirectly related to the relative rates of trend growth in domestic and foreign GDP. Over long periods of time, the income elasticities of imports and exports tend to converge toward each other as trend domestic growth converges toward that of a country’s trading partners over time.7

14. The observation that the ratio of the income elasticity of exports to that of imports has been roughly equal to the ratio of domestic to foreign growth rates is equivalent to the observation that there have not been significant trends in real exchange rates over time if there is no trend in the trade balance. If a country’s economic growth is much faster than that of its trading partners, while the income elasticities of its exports and imports are similar, a trend real depreciation would be required in order for it to find foreign markets for its output in order to balance its external position over time. Similarly, if a country’s income elasticity of exports is much smaller than that of its imports, while domestic and foreign trend growth rates are similar, a real depreciation would be required over time.

15. In the United States, while real GDP growth was lower than in its trading partner countries during the 1970-2000 period, the differential narrowed substantially over time (Table 2). Indeed, during 1992-2000, a period that includes the most recent economic expansion, U.S. growth was ½ percentage point higher than in partner countries. Meanwhile, the real effective exchange rate, notwithstanding marked fluctuations in specific years, has not exhibited a long-term trend.

Table 2.

United States and Trading Partners: Real GDP Growth

(average, in percent)

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Source: World Economic Outlook database.

Weighted by shares in U.S. exports.

16. Accordingly, during the recent period, the income elasticity of exports would be expected to have risen relative to that of imports. Estimates by the staff suggest that this does appear to have been the case during the 1990s. Exports and imports of goods and nonfactor services in constant prices were regressed against real income and relative prices, with both sets of coefficients having the expected sign (Table 3).8 The results suggest that the income elasticity of exports was less than that of imports during 1975-85, but the elasticities converged subsequently at around 1¾, and in recent years the elasticity of exports rose further relative to that of imports. The positive serial correlation in both the export and the import equations, however, suggests an omitted variable in the equations. The addition of lagged regressors alleviates this problem somewhat but evidence of serial correlation remains. The point estimates of the elasticities should thus be interpreted with caution, but the results do suggest that the estimated income elasticities of U.S. exports and imports appear to be converging.

Table 3.

United States: Income and Price Elasticities of Exports and Imports of Goods and Nonfactor Services

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Quarterly data, with all variables expressed in logarithms, t-statistics in parentheses. P(t) refers to the relative price.

Export prices relative to trading partners’ CPI.

17. Over the longer term, if growth rates in the United States and the rest of the world converge, as do the income elasticities of U.S. imports and exports, there remains a question as to whether there may be some fundamental problem that would prevent the U.S. external balance from adjusting to a “sustainable” position. Sustainability in this context would be defined as a long-term current account balance that could be maintained without a continuing, large real depreciation of the dollar. Analysis by the staff suggests that the current account could smoothly adjust to a long-term sustainable position provided the United States continues to follow sound macroeconomic policies, with monetary policy maintaining low inflation and fiscal policy aimed at meeting the long-term financing needs of Social Security and Medicare, while keeping the rest of the budget balanced (Figures 36).9 In this scenario, over the longer term the current account deficit would average around ½ percent of GDP, fluctuating within a range of 0–2½ percent of GDP, following a sizeable correction in the external position in the medium term (roughly the period through 2010). A U S deficit of this size in the long term would absorb around 1 percent of world savings a level that would not be out of line with historical averages.10

Figure 3.
Figure 3.

United States: Current Account Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A002

Figure 4.
Figure 4.

United States: Real Effective Exchange Rate

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A002

Figure 5.
Figure 5.

United States: General Government Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A002

Figure 6.
Figure 6.

United States: General Government Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A002

18. With less fiscal adjustment, the improvement in the current account would be more modest than in the first scenario and the dollar somewhat more depreciated in the long run. An alternative fiscal scenario was examined in which only Social Security is put into actuarial balance and its surplus is saved. It was assumed that no measures are taken to put the Medicare HI system into actuarial balance and that the HI surplus is not saved. After the HI trust fund runs out, it was assumed that HI was financed on a pay-as-you-go basis, with the payroll tax being raised to finance benefits in each year. Nevertheless, this less-ambitious policy stance would still help reduce the current account deficit to 1–3 percent of GDP (around ½ percent of GDP on average) during the longer term although the longer-term output benefits would be smaller than in the first fiscal scenario and the degree of debt consolidation would be smaller.

List of References

  • Cerisola, M., H. Faruqee, and A. Keenan, 1999, “Long-Term Sustainability of the U.S. Current Account Balance,” in United Slates—Selected Issues, IMF Staff Country Report No. 99/101.

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  • Goldstein, M., and M. Khan, 1985, “Income and Price Elasticities in Foreign Trade,” in Ronald Jones and Peter Kenen, editors, Handbook of International Economics, 2, (Amsterdam: North Holland), pp. 10411105.

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  • Houthakker, H., and S. Magee, 1969, “Income and Price Elasticities in World Trade,Review of Economics and Statistics, 51, pp. 111125.

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  • Krugman, P., 1989, “Differences in Income Elasticities and Trends in Real Exchange Rates,” in European Economic Review, 33, pp. 10311054.

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  • Mann, C, 2000, “Is the U.S. Current Account Deficit Sustainable?” in Finance and Development, March, pp. 4245.

  • Obstfeld, M., and K. Rogoff, 2000, “Perspectives on OECD Economic Integration: Implications for U.S. Current Account Adjustment,paper presented at the Federal Reserve Bank of Kansas City symposium, August.

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  • Schott, F., 2000, “Is the U.S. Current Account Deficit Sustainable?” in Business Economics, July 2000, pp. 7273.

1

Prepared by Vivek Arora, Steven Dunaway, and Hamid Faruqee.

2

See, for example, Mann (2000) and Schott (2000).

4

The productivity shock consists of a roughly ¼ percentage point increase in the rate of total factor productivity (TFP) growth and an exogenous 1–2 percent increase in the market value of capital relative to their respective baseline values. The shocks are perceived to be permanent on impact, before dissipating over a period of five years. The reason for adopting a composite shock in the scenario is that a simple TFP shock alone in MULTIMOD does not raise investment significantly relative to consumption. The second component—an additional increase in the market value of capital—raises domestic returns sufficiently to spur domestic investment to a much greater extent, as well as to induce capital inflows and a currency appreciation, in a manner similar to the experience in the United States during the second half of the 1990s.

5

The results are similar if instead U.S. productivity levels fall to levels prevailing in partner countries.

6

See Goldstein and Khan (1985) for a comprehensive review, and Houthakker and Magee (1969).

7

See Krugman (1989). Krugman refers to the relationship between relative trade income elasticities and relative growth rates as the “45-degree rule.”

8

In the export and import equations, real income was captured by real foreign and U.S. GDP, respectively, and relative prices by the ratio of U.S. export prices to the foreign import-weighted consumer price index and the ratio of U.S. import prices to the U.S. GDP deflator. The export price elasticities are very low, and not significant at the 5 percent level for 1975–2000. An alternative specification using the foreign export deflator in place of the foreign CPI suggested that the elasticity of U.S. exports with respect to relative prices was -0.7 during 1975–2000.

9

For actuarial balance, it was assumed that Social Security and Medicare HI payroll taxes are raised such that the present value of expenditures over the 75-year horizon is not larger than the net present value of revenues, and that the trust funds have sufficient resources to cover expenditure for an additional year. See also Cerisola, Faruqee, and Keenan (1999).

10

For partner countries, it is assumed that fiscal policies attain balanced budgets. The simulations also included the saving-investment balance implications of faster population aging in other industrial countries as described in Cerisola, Faruqee, and Keenan (1999).

United States: Selected Issues
Author: International Monetary Fund
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    United States: Global Net Portfolio Inflows by Asset Class

    (Billions of US$)

  • View in gallery

    United States: GDP Growth, Current Account Balance, and Nominal and Real Effective Exchange Rate

  • View in gallery

    United States: Current Account Balance

    (Percent of GDP)

  • View in gallery

    United States: Real Effective Exchange Rate

  • View in gallery

    United States: General Government Balance

    (Percent of GDP)

  • View in gallery

    United States: General Government Debt

    (Percent of GDP)