Thursday, February 23, 2012

>EMPIRICAL & THEMATIC PERSPECTIVES: The Outlook for Global Imbalances

■ In this essay, we document a marked narrowing in the magnitude of global current account imbalances in the years since the financial crisis erupted. In particular, the U.S. deficit has halved from roughly 6 percent of GDP to 3 percent of GDP, and China’s surplus has declined significantly as well. We then consider whether the observed reduction in these imbalances—and in the magnitudes of global imbalances more generally—is only a temporary shift linked to the disruptions associated with the financial crisis or whether these adjustments are likely to be more durable.

 In examining this issue, we first study data for a broad set of G-20 countries. We find evidence that over the past decade, countries with current account deficits have generally seen their currencies depreciate in real terms and this, in turn, has been associated with some closing of their deficits. Conversely, countries with external surpluses have tended to experience real appreciations, and their surpluses have narrowed. These results leave us hopeful that the recent adjustment in imbalances will not be immediately reversed once a stronger global recovery takes hold.

 In the second half of the essay, we build forecasting models to assess the likely path of the U.S. and Chinese balances going forward. For the United States, our conclusion is that under plausible assumptions (flat dollar, moderate growth rates in the U.S. and abroad, and stable oil prices), the current account balance is likely to remain roughly in the neighborhood of 3 percent of GDP. Neither a further deterioration nor a substantial improvement seems to be in the cards over the next several years.

 The outlook for China, however, is more worrisome. Given the significant estimated sensitivity of Chinese exports to foreign GDP growth, our model suggests that an eventual global recovery may bring with it a renewed widening in China’s trade surplus. Our work suggests that a further 15 percent real appreciation of the renminbi will be necessary to keep the Chinese trade balance in a range of 3 to 4 percent of GDP through 2015. This analysis should be interpreted as a cautionary tale for the Chinese authorities.

 On balance, this analysis supports three broad conclusions. First, we see evidence that over the medium to long term (i.e., five to ten years), real exchange rates have tended to adjust in a manner consistent with greater global balance. In this important sense, the international monetary system seems to be functioning reasonably efficiently. Second, in light of this observation and the tenor of the evidence more generally, we expect much of the observed adjustment in global current accounts to prove durable, especially given the sharp depreciation of the dollar over the past decade and the stepdown in U.S. growth. Third, as our empirical work for China highlights, however, the adjustment process is still incomplete. Further exchange rate realignment in some key countries will be necessary to achieve a pattern of global spending and production that is likely to prove sustainable over the long run.