Published on March 16, 2014
Current Account Imbalances: the Cost of a General Adjustment
Introduction Global imbalances have been at the centre of the economic and policy debate in the last decade. While most advanced countries, like the United States, increased their current account deficits, other countries – namely the emerging countries such as China – increased their surpluses. The euro area kept a current account balance at the aggregate level; however there are huge disparities across member states.
Current Account Rebalancing and Exchange rate Adjustment Starting from Obstfeld and Rogoff (2007) two-country model, the goal is to assess the potential consequences for macroeconomic variables (i. e. real exchange rate and terms of trade) of a rebalancing. The focus is concentrated on two main points: 1. The speed of the rebalancing process: in the short run (imperfect pass-through to prices) the exchange rate depreciation can be sharp 2. The role of policy reforms: countries in surplus should concentrate their efforts to improve the productivity in the non-tradable sector and reduce the degree of home bias in consumption, countries in deficits should aim to expand the productivity in the traded goods sector.
The Model General equilibrium approach, two-country model (U.S. vs rest of the world) Endowments exogenous for any type of output Flexible Prices The U.S. as big country, i. e. shocks can alter terms of trade with respect to the rest of the world Perfect pass-through in the long run, but imperfect in the short Home bias in consumption: preferences for home produced goods Law of one price holds Given the endowments and the consumption, it is possible to solve the calibrated system and find solutions for the exchange rate and the terms of trade.
Results and implications The baseline scenario considers the case of an U.S. current deficit adjustment from 3 percent of GDP to zero (full balance) Differently from Obstfeld and Rogoff (2007) model, is introduced an imperfect (50%) pass-through: - real exchange rate depreciation is quite sharp (38% with standard levels of elasticity of substitution between home and foreign goods and tradable and nontradable goods) - terms of trade change is also bigger compared with full pass- through case (18%) - with higher elasticities the fluctuations are smaller If the speed of the is slow enough to offset the incomplete pass-through effects, than the needed exchange rate change is smaller.
Current Account Imbalances within the euro area While the eurozone are in substantial balance at the aggregate levels, there are big an persistent differences between groups of countries. Current Account balance in selected european countries. Source: World Bank Countries like Germany, Netherlands and others are experiencing current account surpluses On the contrary, other countries (especially the “PIIGS” group) are in deficit
Belke and Dreger (2011) The paper (first draft 2011 and published version 2013) tries to determine to what extent current account dynamics can be traced back in catching up and competitiveness factors. Panel integration and cointegration techniques are used, given the presence of stochastic trends in the data.
Belke and Dreger (2011) Catching up: imbalances can reflect a convergence process among countries with different gdp per capita. Competitiveness: in countries with a stronger real exchange rate demand will be redirected from domestic to foreign goods. Hence, countries in deficit can be less competitive because of higher domestic prices. Governments can induce exchange rate depreciation via deflation policies, with adverse effects on the catching up process.
Methodology A panel econometric approach is the more appropriate as time series are enriched with cross-country allowing to have a broader information set The variables are all characterized by stochastic trends, therefore cointegration analysis is used. Since panel members are not independent tests that controls for these dependencies are needed.
Determinants of current account position What are the potential variables to include for a panel regression analysis? Current account balance will be the dependent variable Real exchange rate is a proxy for the competitiveness channel Real GDP per capita proxies the catching up channel Other variables can be included to investigate over the robustness of the results: Government debt / nominal GDP ratio Real interest rate
Prospects of future research After replicating the results of the Belke and Dreger paper it will be interesting to extend and modify the analysis Using different proxies for competitiveness channel: i. e. using a different real exchange rate measure Different aggregates of countries: instead then dividing the sample into surplus and deficit groups it could be useful to aggregate countries with similar export structures Possible other variables not included in the model that can be important in this process: variables related to the spending in welfare system can influence the balance Investigate more the role of the euro currency and the increasing capital integration within the euro area
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