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FINANCE

Global Imbalances

The recent IMF’s External Sector Report highlighted the persistence of imbalances and a switch of imbalances towards advanced economies. We review recent contributions on this topic.

The IMF’s 2017 External Sector Report shows that global current account imbalances were broadly unchanged in 2016. Overall excess current account imbalances (i.e., deficits or surpluses that deviate from desirable levels) represented about one-third of total global imbalances in 2016, increasingly concentrated in advanced economies. Persistent global excess imbalances suggest that automatic adjustment mechanisms are weak. While the rotation of excess imbalances toward advanced economies likely entails lower deficit-financing risks in the near term, the increased concentration of deficits in a few economies carries greater risks of disruptive trade policy actions.

The IMF points out that with nearly-closed output gaps in most systemic economies, addressing external imbalances in a growth-friendly fashion requires a recalibration of the policy mix in deficit and surplus economies alike. Excess deficit countries should move forward with fiscal consolidation, while gradually normalizing monetary policy in tandem with inflation developments. Excess surplus economies with fiscal space should reduce their reliance on easy monetary policy and allow for greater fiscal stimulus. Where monetary policy is constrained from playing a role, as in individual euro area members, fiscal and structural policies to facilitate relative price adjustments should take priority.

Adler and Cubeddu point out that the widening of excess imbalances and the existence of large and persistent surpluses, outside oil-exporting countries and financial centers, is a fairly recent phenomenon in historical terms. The current constellation of excess imbalances suggest that prices and saving and investment decisions are not adjusting fast enough to correct. This partly reflects rigid currency arrangements but also structural features (like inadequate social safety nets and barriers to investment) which lead to undesirable levels of saving and investment in some economies. The concentration of deficits in a few countries raises the likelihood of protectionist measures and the continued reliance on demand from debtor countries risks derailing the global recovery, while raising the chances of a disruptive adjustment down the road. To this extent, a common approach to imbalances is key to avoid that countries acting independently in their own self-interest undermine the common good of growth stability.

Rick Rowden in the Financial Times argues that the IMF got it wrong, and that it is the faulty architecture of the international system as a whole that is responsible for the periodic growth of worrying imbalances in the global economy. The present international system was designed to operate in an asymmetrical fashion in that it places the burden for adjustment entirely on the deficit countries. Meanwhile, the surplus countries are perceived as “winners” to be emulated. Rowden argues that rather than placing the entire burden of adjustment asymmetrically on the deficit countries, the IMF should be championing Keynes’ proposal for establishing a mechanism for co-ordinated and symmetric policy responses to international imbalances.

Otaviano Canuto argues that while not a threat to global financial stability, the resurgence of imbalances reveals a sub-par performance of the global economy in terms of foregone product and employment, i.e. a post-crisis global economic recovery below its potential. The end of the “era of global imbalances” may have been called too early and Lord Keynes’ argument about the asymmetry of adjustments between deficit and surplus economies remains stronger than ever. The IMF report has a point in calling for a “recalibration” of macroeconomic policies from demand-diverting to demand-supportive measures. This would be particularly the case for countries – or the Eurozone as a whole – currently able to resort to expansionary fiscal policies that have instead relied mainly on unconventional monetary policy. On the other hand, one must acknowledge that there are limits to which national fiscal policies can deliver cross-border demand-pull effects. Huge savings flows – like German or US corporate profits – may also not be easy to redeploy.

Ueda and Monge-Naranjo take a longer historical perspective. Based on historical data since 1845, they identify a stylized fact, namely, alternating waves in global imbalances generated by sequential industrial revolutions, as newly industrialized countries grow rapidly and often accumulate foreign assets. They propose a new theoretical model to explain this stylized fact by applying the sequential industrial revolution model of Lucas (2004) to an open economy setup, combined with the hard currency (gold) constraint to buy consumption goods.

Carmen Reinhart thinks that the more things change, the more they stay the same. For most of the last four decades, the United States has been a net importer of capital from the rest of the world. After it emerged as a world power at the end of World War I, the US became a net supplier of capital to the rest of the world. The finger has been pointed at different countries over time: Japan and South Korea in the late 1980s, China and more recently Germany, with currency manipulation often cited for the rise in external saving. Reinhart argues that as the US has run chronic current-account deficits for almost two generations, pointing the finger at surplus countries is getting old. Some ask whether international pressure could be exerted on the surplus countries to spend more and save less, but when the same question was put to the US in its era of surpluses at the end of World War II, it was dismissed unequivocally. US tax policy has favored debt accumulation by households at the expense of saving, and a significant productivity slowdown is affecting US international competitiveness. For lack of alternatives, the dollar’s status as the world’s major reserve currency remains unchallenged, and it is easy for the US to finance current-account deficits, but the fact that it is easy does not make it a good idea.

Choi and Taylor argue that widening global imbalances, driven by reserve accumulation, can help us investigate how real exchange rates are determined. The standard textbook view that stretches back to the works of Hume and Keynes, would argue that there is a clear steady-state relationship in which the real exchange rate (RER) appreciates if there is an increase in net foreign assets. Using recent data from 75 countries that they argue that looking at reserve accumulation can overturn this standard view. Their empirical results show that between 1975 and 2007, controlling for GDP and the terms of trade, private external assets were associated with appreciation of the real exchange rate. Yet public external assets had little effect on the real exchange rate in financially open countries, and were associated with real exchange rate depreciation in financially closed countries. They then propose a theoretical model of precautionary and mercantilist motives with two competing forces to account for the result: on one hand, the desire to hold reserves as precautionary stockpile against crisis losses and capital market exclusion; on the other hand, the desire to use real exchange rate and capital account policies to force external saving through a trade surplus when there is an export-led growth externality.

-SILVIA MERLER

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