perspectives on the u. s. current account deficit and sustainability14.54/handouts/mann.pdf ·...

Perspectives on the US CurrentAccount De cit and Sustainability

Catherine L Mann

T he US current account balance has been deeply in de cit in recent yearsincluding the record $410 billion de cit in 2000 42 percent of GDPfollowed by $393 billion in 2001 By de nition an economy running a

current account de cit will experience an overall net capital in ow as foreignerson net buy US rms stocks bonds Treasury obligations and currencymdashand alsomake bank loans in exchange for US purchases of imported goods and servicesA current account de cit can mean that a country is ldquoliving beyond its meansrdquobecause overall consumption and investment exceed the national savings of theeconomy Alternatively it can mean that a country is an ldquooasis of prosperityrdquoattracting investment from around the globe because the economy delivers higherinvestment returns at lower risk than other investment choices

By the mid-1980s the accumulation of the current account de cits and netforeign capital in ows had turned the net international investment position of theUnited States from positive to negative that is foreign investors now hold moreUS assets than US investors hold of foreign assets1 By the end of the year 2001the net international investment position of the US economy was about negative$2 trillion or 20 percent of GDP

The negative net international investment position bears on the question of

1 The exact year when the net international investment position turned negative depends on whetherdirect investment is calculated at current cost of plant equipment and land or whether stock marketprices are used to value the equity assets (Landefeld and Lawson 1991) Calculated at current cost thenet international investment position turned negative in 1986 and the net international investmentposition in 2000 was $14 trillion Calculated at market value the net international investment positionturned negative in 1988 and the net international investment position in 2000 was $16 trillion See King(2001)

y Catherine L Mann is Senior Fellow Institute for International Economics WashingtonDC Her e-mail address is CLMannIIEcom

Journal of Economic PerspectivesmdashVolume 16 Number 3mdashSummer 2002mdashPages 131ndash152

the sustainability of the current account de cit and the associated in ow of capitalThe large stock of nancial obligations implies ows of income payments andreceiptsmdashinterest dividends and the likemdashthat must be paid out of the economyrsquoscurrent production and that could get large enough to reduce current consump-tion and investment Moreover even a large economy such as the United Statesmust consider the implications of a change in foreign investor sentiment about thedesirability of holding a large share of US assets in their portfolios and ofcontinuing to provide the net in ow of nancial capital

Figure 1 shows the current account de cit and its main component the goodsand services trade balance as a share of US GDP since 1973 Table 1 shows themagnitude in dollar terms for selected years of these two main balances along withthe remaining two components of the current account net income payments onthe net international investment position and unilateral transfers (such as US

Table 1US External Balance and Components Selected Years (billions of dollars)

1980 1985 1990 1995 2001

Current Account 23 21182 2790 21058 23934Goods and Services 2194 21219 2809 2964 23583Net Income 301 257 286 246 144Net Unilateral Transfers 283 2220 2267 2341 2495

Source Bureau of Economic Analysis Department of Commerce httpwwwbeadocgov Reviseddata 6202002

Figure 1Overview of the External De cits and the Dollar

Source External Balances Bureau of Economic Analysis Department of Commerce httpwwwbeadocgov Real exchange rate Federal Reserve Board httpwwwfederalreservegov

132 Journal of Economic Perspectives

grants to foreign countries and private remittances) Since the late 1970s the UStrade balance has been in de cit It widened dramatically when the US economywas growing strongly relative to the world economy in the mid-1980s and thesecond half of the 1990s and it narrowed in the early 1990s when the US economygrew more slowly than the global economy Also shown on Figure 1 is the realexchange value of the dollar which is the international asset price companion tothe current account The real exchange value of the dollar also has exhibited largeswings most notably the appreciation-depreciation cycle of the mid-1980s In the1990s the dollar has appreciated signi cantly as well

One consequence of the change in the net international investment positioncan be seen in the net income line in Table 1 When the net internationalinvestment position was positive in the 1970s and early 1980s the US economyreceived net income from its investments abroad In 1980 for example a goods andservices trade de cit of $19 billion was offset by net income of $30 billion fromforeign investments As the net international investment position turned negativethe net income balance has gotten smaller but was still a positive $14 billion in2001

A more detailed look at the composition of trade in goods and services revealsthat some sectors are characterized by cyclical uctuations whereas for others atrend is apparent Figure 2 relies on ldquoend-userdquo categories compiled by the Bureauof Economic Analysis of the US Department of Commerce It combines some ofthese categories into three sectors capital goods and nonenergy industry suppliesconsumer goods and autos and services Figure 2 shows that the trade surplus oncapital goods and nonenergy industrial supplies which are closely associated withchanges in business demand for investment goods uctuates with the businesscycle In contrast the trade balance for consumer goods and autos has been

Figure 2Trade Balance by Important Sector(millions of dollars)

Source US Census httpwwwcensusgovforeign-trade

Catherine L Mann 133

persistently and increasingly negative whereas that for services persistentlypositive

This essay considers the underpinnings of the large US current accountde cit It then tackles the question of whether the US current account de cit issustainable A current account de cit is ldquosustainablerdquo at a point in time if neitherit nor the associated foreign capital in ows nor the negative net internationalinvestment position are large enough to induce signi cant changes in economicvariables such as consumption or investment or interest rates or exchange ratesEven if the current account de cit is sustainable by this de nition today itstrajectory could still be creating future risks for the US and global economy

Three Perspectives on the Current Account Balance

In some sense focusing on the current account balance is misguided After allthe current account is not a fundamental economic force in itself but only onemanifestation of the general equilibrium interaction between many factors domes-tic rates of saving and investment economic growth and trade internationalinvestment and capital ows prices and rates of return and the exchange rate and scal and monetary policy Although certain general equilibrium models encom-pass many features of the domestic and international economic interrelationships(like Knight and Scacciavillani 1998) it is useful and common to take one of threeperspectives on the current account de cit 1) a domestic perspective based onnational income and product accounts 2) an international perspective based ontrade ows in goods and services and 3) an international perspective based on ows and holdings of nancial assets These three perspectives are different lensesthrough which to analyze the general equilibrium system Each perspective involvesa decision to focus on certain variables or economic relationships and to de-emphasize or even ignore other variables and relationships Each perspective maybe particularly useful in certain situations or time frames All together the threeperspectives give views that are consistent and mutually reinforcing

A Domestic Perspective Based on the National Income and Product AccountsThe rst perspective on the current account de cit is based on the domestic

national income and product accounts and shows how patterns of domestic savingsand investment are re ected in the trade and current account balances In thenational accounts framework it is an identity that domestic production in aneconomy must equal spending plus the trade balance In the case of a trade de cita nationrsquos spending will exceed its domestic production which yields the observa-tion that in a static sense the United States has been ldquospending beyond its meansrdquoA common arrangement of the national income and product account variables inthe 1980s placed the two main sources of saving private domestic saving and theforeign capital in ow due to the current account de cit on one side of the identity


with the two main sources of demand for nancial capital private sector investmentand the government budget de cit on the other side2

domesticprivatesaving

1tradedeficit 5

privateinvestment 1

governmentbudgetdeficit

This form of the identity highlights that if domestic private savings andinvestment are roughly equal or at least move by about the same amount then the scal and current account de cits are twinsmdashabout the same size and moving in thesame way Indeed this pattern of events occurred in the 1980s From 1983 to 1989private savings and investment did move together and by arithmetic so did the scal budget and current account de cits From 1980 to 1986 the federal budgetde cit increased from 27 percent of GDP to 5 percent of GDP and the currentaccount de cit increased from 0 to 35 percent of GDP The two were called theldquotwin de citsrdquo not only because they increased by about the same amount but alsobecause they derived from similar policy fundamentals During the 1980s expan-sionary scal policy through large budget de cits yielded robust domestic spendingthat supported both growth of US GDP and increased imports The governmentde cit increased demand in the capital markets and monetary policy was tightboth of which kept interest rates high High interest rates attracted foreign invest-ment appreciating the exchange value of the dollar The appreciated dollar madeUS exports more expensive for foreigners to buy and imports cheaper Thus thecurrent account de cit widened in the 1980s as the scal stimulus yielded bothrobust US economic growth and an appreciation of the dollar The de cits weretwinned through the mechanism linking the scal budget de cit to GDP growthand high interest rates to high imports and appreciated dollar to the currentaccount de cit

By the late 1990s the federal budget de cit had moved into surplus but thecurrent account de cit widened What changed to separate the former twins Thechain of causality starting with a large scal de cit and ending with a large currentaccount de cit could have unwound in reverse A reduced scal stimulus couldhave reduced demand throughout the economy including demand for importsThe smaller scal de cit also could have taken the pressure off the costs of fundsin nancial markets and interest rates With lower interest rates the demand forUS and dollar-denominated assets could have fallen and the dollar depreciated

2 Recall that in the national income and product accounts identity production equals spending alsoimplies that savings equals investment (S 5 I ) Savings has three components private savings (Sp)comprised of household savings and corporate pro ts public savings or the scal budget position(T ndash G) and foreign savings or the inverse of the trade de cit (M ndash X ) Substituting and recombiningyields the identity for sources and uses of funds Sp 1 (M ndash X ) 5 I 1 (G ndash T ) If government savingsbecame a surplus then it would shift sides of this equation and appear as (T ndash G) on the other side asa source of funds Similarly if the trade balance became positive it would shift sides of this equation andappear as (X ndash M ) on the other side as a use of funds

Perspectives on the US Current Account Decit and Sustainability 135

all of which would help to narrow the current account de cit Indeed for a shortperiod in the early 1990s the variables seemed likely to follow this course

But then the ldquonew economyrdquo arrived the realization of ef ciency gainscost reductions and productivity enhancements from using information andcommunication technologies in an environment of heightened global competitionand leading to the transformation of business activities3 For present purposes thekey importance of the new economy phenomenon is that it drove a wedge betweenprivate investment and private savings

On the one hand business investment boomed in the 1990smdashparticularly ininformation technologiesmdashrising from 55 percent of GDP in 1992 to 86 percentof GDP in 2000 The productivity gains associated with effective use of this invest-ment contributed to an unprecedented rise in the US stock market and to othervaluations of the rates of return on business investments The US economy was infact an ldquooasis of prosperityrdquo at this time Along with the economic environment oflow unemployment households became more con dent of the future value of theirwealth So household savings a key component of private savings declined dra-matically from 65 percent of GDP in 1992 to less than 1 percent of GDP in 20004

Despite greater public savings from the federal budget moving from a de cit of48 percent of GDP in 1992 to a budget surplus of 25 percent of GDP in 2000national savings was insuf cient to nance the high rate of private investment5

The productivity gains in the US economy and the huge increases in USstock market values also attracted foreign investors Despite low interest rates onbonds foreign capital in ows kept the value of the dollar high as foreigners soughtout the high returns of the US economy and invested their savings here contrib-uting at the same time to the nancial sources for innovation and robust produc-tivity growth Because of the high investment in a hospitable market environmentand the attraction of foreign capital the chain of causality that had related the scalposition to the current account position in the 1980s was broken in the 1990s

3 For discussions of the ldquonew economyrdquo phenomenon in this journal see Baily (2002) and the Sympo-sium on Computers and Productivity in the Fall 2000 issue along with the articles cited therein4 The of cial household savings rate is a residual calculation from the national income and productaccount de nitions personal disposable income minus personal consumption outlays Its relationshipto the economic concept of saving is questionable and its trend behavior over time has become quitecontroversial (particularly as the measured rate fell below zero in 1999 as initially calculated althoughit was subsequently revised) Gale and Sabelhaus (1999) show that if the de nition based on the nationalincome and product accounts is adjusted for other forms of retirement saving (such as federal and stateretirement plans) the decline in the household savings rate is somewhat less dramatic By includingconsumer durables in household savings as well as adjusting for in ation and certain taxes the rate ofdecline levels out even more Finally including capital gains makes a huge difference indeed it reversesthe measured decline Whether to include the volatile capital gains component in savings is open toquestion5 There is a statistical discrepancy between gross domestic productmdashwhich is the value of expendi-turesmdashand gross domestic incomemdashwhich is the income earned These two values of the total economyshould be the same but they come from different source data and in recent years gross domesticincome has been higher by some 05 percent of GDP The gap seems to be widening gross domesticincome was 08 percent of GDP higher in 1999 and 13 percent higher in 2000 How the statisticaldiscrepancy might be allocated to consumption and investment affects the macroeconomic identitiesparticularly the savings-investment balance For more discussion see Mann (1999 pp 25ndash27)


A Perspective Based on International Trade in Goods and ServicesThe second viewpoint on the current account is an international perspective

based on the factors that underpin the ows of exports and imports of goods andservices The previous perspective may have implied that foreigners respond pas-sively to the demands re ected in our national accounts For example if a gapopens up between low private savings and high investment in the US economy the rst perspective seems to imply that foreign investors will simply consume less andsave and invest as much as the US economy needs to nance its investment Thesecond perspective focusing on the forces that drive export and import owsprovides an explicit role for foreign demand for goods and services This alternativeframework allows us to examine how global and national GDP growth as well as theexchange rate can affect the current account It also allows us to consider theimpact on trade and the current account of structural factors such as comparativeadvantage and globalization

A useful starting point for this perspective is a model in which growth ofnational income and changes in relative prices drive trade ows (Marquez andEricsson 1993) In this model exports grow faster when foreign income growsfaster and when the relative price of exports to competing goods and services in thedestination market falls Imports grow faster when domestic income grows fasterand when the relative price of imports to domestic goods and services falls6

Figure 3 illustrates the US experience The top panel graphs annual changes inUS exports on the left-hand axis and changes in real world GDP (excluding theUS economy) on the right-hand axis The bottom panel graphs annual changes inUS imports on the left-hand axis and changes in real US GDP on the right-handaxis The close relationship between GDP growth and real import and exportgrowth is quite clear

Examining the two panels also reveals the role of relative prices of exports forexport growth and of imports for import growth When the dollar depreciatedsharply between 1986 and 1989 the relative price of US imports tended to risemaking domestic products more attractively priced and the relative price of USexports tended to fall making US products more attractively priced in thedestination markets Thus in the bottom panel in the years around the dramaticdepreciation of the dollar imports grew more slowly than would have been ex-pected based on the growth of US GDP alone (that is the dotted line is below thesolid line) In the top panel US exports grew more quickly from 1986 to 1989 thanwould have been expected on the basis of foreign growth alone (thus the dottedline above the solid line)

When equations are estimated for the effect of national income and rela-tive prices on imports and exports the estimated parameters generally produce

6 As discussed in Mann (1999 pp 96ndash99 117ndash119) the relative price of US-traded goods and serviceshas several components the cost of production of the good or service by the home or foreign producerthe rmrsquos markup over cost and the nominal exchange value of the dollar which allows a buyer tocompare prices in a common currency The real exchange value of the dollar appropriately tradeweighted summarizes these factors


excellent in-sample and predictive results However the empirical values in thesestudies present a puzzle In every study where goods and services are aggregatedthe US income elasticity for imports of goods and services is signi cantly greaterthan the foreign income elasticity for US exports of goods and services Forexample Hooper Johnson and Marquez (1998) found that the long-run elasticityof US exports of goods and services with respect to foreign national income was080 while the long-run elasticity of US imports of goods and services with respectto US national income was 180 This asymmetry appears consistently in analysesover different estimation periods data and econometric techniques (Houthakkerand Magee 1969 Cline 1989 Wren-Lewis and Driver 1998) (The pattern is alsorevealed in Figure 3 by the different left-axis scales in the two panels) Theasymmetry of how US income affects imports and how world income affects USexports means that if the US economy and the rest of the world grow at the samerate the current account de cit will continue to widen unless the exchange value

Figure 3US Exports and Foreign GDP

Imports and US GDP

Source GDP World Development Indicators 2001Trade Bureau of Economic Analysis Department of Commerce


of the dollar persistently depreciates (Krugman 1985 Marris 1985 Krugman andBaldwin 1987 Obstfeld and Rogoff 2000)

Much research investigates the puzzle of the income asymmetry Some of theresearch considers additional international variables that may be important Forexample failing to include increases in international capacity to produce ignoringthe entry of new international competitors or poor accounting for new intermedi-ate products in trade means that the import price measure probably is overstatedmdashwith the result that the estimated coef cient on US income is biased up inestimation (Helkie and Hooper 1988 Hooper and Mann 1989 Mann 1991Feenstra and Shiells 1997)

Other researchers have focused on variables important to the characteristics ofthe US marketplace that might be missing Demographic variablesmdashsuch asimmigrants and the age distribution of the US population relative to that of ourmajor trading partnersmdashmay be important to solving the econometric puzzle Forexample immigrants (who represent about 10 percent of the US populationtwice the share in the 1960s) maintain their tastes for their home products longafter moving to the United States and also send home remittances (which as acapital out ow adds to the current account de cit) Moreover a relatively youngsociety like the United States will import more than relatively old societies ofEurope and Japan which tend to consume a higher fraction of domestic servicessuch as health care (Gould 1994 Marquez 2002)

The income asymmetrymdashalong with its manifestation in the current accountde citmdashmight gradually attenuate as the worldrsquos economies mature and spendmore on services (which are becoming increasingly tradable) and less on manu-factured goods Although the income asymmetry is quite pronounced for US tradein goods it is nearly absent or is reversed in certain categories of US trade inservices For example Wren-Lewis and Driver (1998) nd that while the elasticityfor US exports of goods with respect to foreign income is 12 the elasticity of USimports of goods with respect to US income is 236 However they also nd thatthe elasticity of US exports of services with respect to foreign income is 195 whilethe elasticity of US imports of services with respect to US income is 172 (see alsothe results in Deardorff et al 2001 Dee and Hanslow 2001) As foreign economiesdevelop and mature some of their growing demand for services will spill over intopurchases of US service exports particularly if the services sector achieves greaterliberalization through multilateral trade negotiations which would tend to reducethe overall estimated asymmetry (Mann 1999 pp 37ndash41 88ndash89 footnote 21 andp 170)

What about the role of relative prices in affecting the trend current accountde cit As noted a good proxy for relative prices is the real exchange value of thedollar which has been appreciating since the mid-1990s at about the same time asthe relatively faster productivity growth of the new economy began to emerge in theUS data Is there a relationship between productivity growth and the real ex-change rate and is there any implication for the current account de cit

The trend appreciation of the US dollar in part re ects the fact that theUS experience of the 1990smdashtechnology uptake rapid globalization robust


competition and higher productivity growthmdash has not been matched by othermajor industrial economies (Marston 1987 Tille Stoffels and Gorbachev 2001Alquist and Chinn 2002) Indeed since increasing global competition is a potentforce transforming business activities and yielding increased productivity growththe great increase in the exposure of the US manufacturing industry to globalcompetition during the last 15 years strongly complements the technologicalfoundation for productivity growth in the United States (Baily and Gersback 1995Jensen and Musick 1996 Helpmann 1997 Mann 1998 Rosen and Richardson2001) But although the trend appreciation of the US dollar since 1995 growsfrom a fundamentally positive eventmdashthat is robust productivity growthmdashit none-theless serves to widen the current account de cit further

A Global Perspective from International Capital MarketsThe third viewpoint on the current account de cit focuses on international

ows of nancial assets This perspective considers how differential rates of returnaffect nancial ows and the exchange value of the dollar as well as the desiredportfolio allocation of wealth (Frenkel and Mussa 1985)

The gross value of international nancial transactions is enormous and in-creasing rapidly As one example gross foreign purchases of US assets rangedbetween $100 billion and $250 billion each year from 1985 to 1994 but haveexceeded $400 billion every year since then topping $1 trillion in 2000 Trading inforeign currencies now totals about $12 trillion each day (Bank for InternationalSettlements 2002) The sheer size of international nancial markets raises hardquestions Is the current account simply determined by international capital owswhich have burgeoned beyond all relationship to real trade transactions If so havethe perspectives on the current account that are based on domestic nationalaccounting identities or on ows of trade in goods and services (the rst twoperspectives) become obsolete

The relationship between international capital ows and international trade ows appears to have changed in two important ways in recent years thanks to nancial innovation and information and communication technology First trans-actions can be consummated much more speedily Asset prices such as interest ratesand exchange rates change nearly immediately whereas real ows of trade in goodsand services adjust more slowly In addition expectations about a countryrsquos pro le ofrisk and return are particularly important in the quick response market of nancialcapital When real or expected performance changes a tension develops betweenthe very rapid response of nancial ows and the slower response of trade owsThis tension invariably will be re ected in the prices that can adjust most quicklyand freelymdashthat is asset prices particularly market driven exchange rates (Dorn-busch 1976) The second important change is that a greater diversity of nancialassets and instruments is available The expanding diversity of sophisticated tech-niques and instruments of nancial intermediation priced using complex analyt-ical models allow investors to target the types of risk they wish to undertake and toleverage their bets In addition because the returns on assets of different countriesin different currencies and at different maturities are imperfectly correlated with


each other and with the returns on nancial assets of the home country andcurrency an investor who holds a diversi ed portfolio can achieve a higher returnfor lower risk than would be possible with domestic nancial assets alone (Grubel1968 Lewis 1995 Tesar and Werner 1998) In this view the gains from tradeshould no longer be measured only in the real domain of goods and services butshould also be measured in how increased nancial intermediation can improve onthe risk and return frontier of the international wealth portfolio

However there is ample evidence that global investors do not diversify theirportfolios often holding a disproportionate share of ldquohomerdquo assets in their port-folio and that global investors sometimes stampede in a nancial herd when facedwith new information or changed sentiment about the quality or price of the assetsthey hold (Tesar and Werner 1998 Lewis 1999 De Brower 2001) In such amarket increased speed of transactions and a greater diversity of nancial instru-ments can increase the volatility of nancial ows If the large US current accountde cit is viewed against this backdrop even if foreign investors are currentlyenjoying ldquonew economyrdquo returns will they continue to be satis ed Is the USeconomy vulnerable to an international nancial market crisis along the lines ofthose suffered around the globe in the last decade

If foreign investors became concerned about risks in the US economy eventswould unfold much differently than in east Asia Russia Argentina and others whohave been hit by international nancial crises The characteristics of how the USeconomy nances its current account de cit in uences how a change in investorsentiment might be re ected in international nancial ows the exchange value ofthe dollar and the amount by which the US current account de cit would need toadjust

The US marketplace has a very broad range of diverse nancial instrumentsmdashstocks and bonds of all risk levels with a wide array of derivative nancial instru-ments for those concerned about speci c risks or time horizons US markets forthese nancial instruments are deep and liquid The market capitalization of theUS stock markets is half of the global total As a result foreign or domesticinvestors who are concerned about asset-type or maturity risk can adjust theirportfolios simply by changing the composition of US assets in their portfolios Forexample they can move from say US stocks to Treasury securities with no needto leave the US credit market altogether

But what if investors do want to limit their overall exposure to US credit andcurrency risk The speci c characteristics of the nancial in ows to the USeconomy still provide some stability Financial in ows can take a variety of formsforeign direct investment portfolio holdings of stocks and bonds bank loans andholdings of government and agency securities The bulk of net nancing of the UScurrent account de cit is in the form of direct investment and private equity andbonds as shown in Table 27 Should a large number of investors wish to reduce

7 The dividing line between a direct investment and a portfolio holding is that direct investment isde ned as cross-border capital ows associated with a company where the nondomestic ownership stakeis greater than 10 percent


their exposure to US assets the prices of these assets would decline In particularstock and bond prices would fall as foreign and domestic investors sold some fromtheir portfolios While a fall in the price of these assets would harm the economyby reducing national wealth as well as by injuring consumer and business con -dence and raising the cost of capital the effects on real output are likely to bemuted by the fact that lower prices of stocks and bonds would attract otherinvestors ldquobargain seekersrdquo thus tempering the price fall and providing anongoing ow of capital Because US assets are such a large portion of the globalinvestorrsquos portfolio changes in sentiment are less likely to be monolithic and morelikely to be self-righting than would be the case for countries whose assets representthe fringe of the portfolio

Moreover the dollar is the unit of account for about 80 percent of cross-borderbank loans For many of the countries that suffered international nancial crisesnot only was most of their foreign nancing in the form of less marketable bankloans rather than private equity and bonds but most of these loans were notdenominated in their home currency When foreign capital started to exit and thelocal exchange rate plummeted what banks earned in local currency was insuf -cient to repay their US dollar loans (and the local currency cash ow of thosecompanies also collapsed) Since the US capital in ow is denominated in USdollars US nancial institutions are not exposed to this same exchange rate risk

To be sure the US economy is not immune to a loss of con dence whetherit be instigated by foreign or domestic investors A fall in the stock market and bondprices would hurt Interest rates might rise to try to attract capital Consumercon dence would be shaken and consumption could slow or decline Investment inplant equipment and software would stall as capital costs rose Indeed thesechanges are the channels through which trade ows (speci cally imports) equili-brate to the smaller desired net foreign investment in the US economy This linkbetween reduced in ows of international capital higher domestic saving (lessconsumption) and lower investment and lower import growth leads us back to thedomestic perspective on the current account balance based on the national ac-counting identities and the perspective of import and export ows showing howthese perspectives are mutually consistent and reinforcing

Table 2Foreign Purchases of US Assets Net(billions of dollars)

1980 1985 1990 1995 2000 2001

Of cial Assets 2155 11 2339 21099 2376 252Direct Investment 2169 2200 2479 2578 23077 21308US Treasury Securities and Currency 271 2256 2163 21038 758 2158US Stocks and Bonds 255 2510 216 2772 24552 24077Banknonbank assets 2176 2509 2413 2898 22913 21930Total 2626 21464 21410 24385 210160 27525

Source Bureau of Economic Analysis US Department of Commerce httpwwwbeadocgov


Two Views of Current Account Sustainability

Analyzing whether the US current account de cit is sustainable shouldconsider two views 1) the domestic view of US consumption and investmentspending and 2) the international nancial view of the global investorrsquos portfolioof wealth Current account sustainability is not only about how much the USeconomy can afford to borrow from the rest of the world It is also about how muchinvestors in other countries are willing to buy and hold US assets in their portfoliosof wealth These two sides to sustainability allow us to integrate the three perspec-tives on the current account

What does it mean for the current account to be ldquosustainablerdquo Sustainablemeans that the external imbalance generates no economic forces that change itstrajectory From the domestic point of view a sustainable current account trajectoryis one where the feedback effects from the current account or net internationalinvestment position to consumption or business investment spending are relativelyweak in comparison to other macroeconomic forces that affect these spendingcategories From the international nance point of view a sustainable currentaccount is one where the feedback effects from international portfolio rebalancingto US interest rates or the exchange rate are relatively weak in comparison toother macroeconomic forces that affect asset prices and portfolio choices

Sustainability and the Domestic Economy Interest Service Spending andDomestic Output

A large and persistent current account de cit portends a negative net inter-national investment position that grows ever larger Eventually the nancial pay-ments arising from this negative net investment positionmdashsuch as interest anddividendsmdashmight become large enough to cut into current consumption andbusiness investment In this case the current account de cit itself would generatechanges in GDP growth and thus in import spending which would make its presentlevel unsustainable

Even a large current account de cit need not engender these feedback rela-tionships however (Milesi-Ferretti and Razin 1996) The higher the trend growthrate of the economy the easier it is to service interest and principal on theaccumulated stock of net international investment obligations without signi cantlyaffecting the behavior of domestic spending Hence higher long-run growth allowsa country to continue running a current account de cit for longer than a countrywith slower long-run growth If foreign capital in ows have helped to increase theproductivity growth of the US economy then the resulting increase in long-termGDP growth enhances the capacity of the economy to pay the nancial service

Certain international nancial obligations like equity investments and foreigndirect investment do not require payments to investors whereas bonds and otherloans do require payments at speci c times The lower the stream of payments thatis required to foreign investors the longer a country can run current accountde cits because the interest service component does not build up so quickly Inaddition the higher the share of obligations in the countryrsquos own currency the less


vulnerable the country is to exchange rate volatility Hence a country that issuesassets mostly in its own currency at low interest rates and with a high share ofequity can continue along its trajectory of spending and saving for longer thancould a country that borrows in currencies other than its own at high interest ratesand using xed maturity bank debt This of course closely matches the character-istics of US net nancing

There is a point at which borrowing is too much but how to pin down thatpoint One gauge is to consider the intertemporal budget constraint (Obstfeld andRogoff 1985) If an economy running current account de cits today has to repayin the future principal (the net international investment position) plus interest toforeign investors then this economy must start running trade surpluses at somepoint If the accumulation of expected future trade surpluses is too small theprincipal plus interest cannot be fully repaid which means that the current accountde cit now is too large In this case the ratio of the current account de cit to GDPmay be the measure to consider If we do not require the economy to repay theprincipal then a current account de cit can continue so long as the accumulatingnegative net international investment position is growing less rapidly than thecapacity of the economy to service the debt that is the net international investmentpositionGDP ratio may not need to turn positive but at some point it needs to stopbecoming ever more negative But at what ratio

In a world of certainty everyone can ldquodo the mathrdquo When a country runs aseries of current account de cits that are so large that the risk of nonrepaymentbecomes nonnegligible global investors refuse to buy assets from that country atthe going interest rate and exchange rate As a result either interest rates rise (totry to attract foreign investors) andor the exchange rate depreciates (becausedemand falls) both of which also serve to ratify the decision by the home consumerand business to save more consume and invest less and buy fewer imports Thusthis is a scenario where the current account de cit has gotten large enough tochange the current trajectory of consumption and investment and the terms of nance (interest rates or exchange values) which means it was unsustainable by thede nition

For industrial countries a ratio of current account de cit to GDP of some-where between 4 and 5 percent appears to be associated with the onset of economicforces (including a monetary policy response a reduction in income and in somecases a real depreciation) that reduce consumption and particularly investmentand change the trajectory of the current account and return it to sustainableterritory (Mann 1999 Freund 2000 Chinn and Prasad 2000) For example inAustralia in 1989 the current account de cit to GDP ratio was more than 6 percentand a real depreciation of some 21 percent among other policy and structuralchanges yielded a current account de cit to GDP ratio of less than 4 percent somethree years later (Freund 2000) Similarly econometric analysis using panel data nds statistical support that a large negative net international investment positionis associated with a depreciation of the relevant exchange rate but the magnitudeof net international investment that is associated with the exchange rate movementis not clear (Gagnon 1996) In any case the applicability of the average experience


of industrial countries to the US economy may be inappropriate given thecomposition of foreign purchases of US assets

For the US economy the ratio of the current account de cit to GDP was42 percent in 2000 and the net international investment positionGDP was about20 percent Was the fall in stock market prices and the decline in domesticinvestment in 2000 and 2001 indicative of the early stages of an unsustainablecurrent account trajectory that the service on the net international investmentposition was getting too great and affecting consumption and investment or thatforeign investors were concerned about the net nancing requirements of thecurrent account de cit This connection seems unlikely given that nancial serviceon the net international investment position in fact was a small positive valueproductivity growth remained robust and the dollar continued to appreciate evenas interest rates fell dramatically throughout 20018 Rather than being a sustain-ability episode driven by the current account de cit a more reasonable interpre-tation is that changes in US stock markets and investment levels from 2000 to 2001were a response to earlier monetary policy decisions and greater realism on the partof investors regarding the near-term value of dot-com investments

Sustainability and International Finance Allocating the Global Wealth PortfolioIf a large US current account de cit is to be sustained global investors must

be willing to purchase US assets at current prices including the going interest rateand exchange rate If the global demand for US assets at current prices is lowerthan what the US economy is offering into the global marketplace by running acurrent account de cit then foreign investors may demand a higher return orinterest rate or they may sell (or not purchase) US investments causing the dollarto depreciate When these economic forces are set in motion a current accountde cit is revealed to be unsustainable from the point of view of the global investor

How much the global investor is willing to invest in the US economy is afunction of several factors including the risk-return pro le of the US obligationsrelative to nancial assets of other countries the growth of the investorrsquos portfolioof wealth transactions costs information and regulation (Branson and Henderson1985 Levich 1998) Estimating a sustainability benchmark based on the share ofUS assets in the global investorrsquos portfolio is dif cult (Isard and Steckler 1985Meade and Thomas 1993 Ventura 2001) The empirical record is thin and givensigni cant innovations in international nancial markets in recent years analysisbased on historical data may not extrapolate well to the present and future TheUS offering of nancial assets into the international marketplace is very big buthow big relative to global wealth

One approach is to consider US net capital in ows relative to global savingsBy this measure the US current account absorbs only about 6 percent of worldsavings which seems to leave plenty of room in the global investorrsquos portfolio for

8 Researchers for some time have wondered how the balance of net income can still be positive given therelatively rapid change from being a net creditor (net international investment position positive) to netdebtor (net international investment position negative) See Mataloni (2000)


more US assets (Cooper 2001) But despite globalization of nance and nancialinstitutions market participants put the majority of their wealth into assets fromtheir own country Much of this ldquohome biasrdquo might be due to regulatory constraintsas well as information and transactions costs but some is better regarded as amatter of taste (Tesar and Werner 1998 Lewis 1999) Consequently the relevantglobal wealth available to make international investments is much smaller thanglobal savings might imply

Another benchmark might be that the US current account absorbs about60 percent of the global aggregated trade surplus measured as the sum of allcountries running trade surpluses (International Monetary Fund 2000) This gure gives the impression of a global investor ush with US assets However justas the previous comparison to global savings was too broad this comparison isundoubtedly too narrow since it does not account for the investment possibilitiesopened up by nancial leverage or derivative instruments

It is not just the stock of global savings or the global trade account that mattersbut how much these grow over time in comparison to how quickly the ldquosupplyrdquoincreases of US assets offered into the international marketplace (as measured bythe current account de cit) The change in global wealth as well as the supply ofUS assets offered depend on economic activity and productivity growth in theUS economy and abroad as well as on nancial innovation and deregulation

With these cautions duly noted Figure 4 presents a different view of theimportance of US investments in the global bond and equity markets Considerequities rst If the global investor simply ldquoheld the marketrdquo by allocating herportfolio to mirror the size of the stock markets around the world her portfoliowould be the so-called ldquoneutralrdquo portfolio measured by the Morgan Stanley CapitalInternational index (the thick black line) By this measure the neutral investorrsquosholdings of US equities should have increased from about 35 percent of theportfolio of equities in 1995 to about 57 percent of the equity component of theportfolio at the end of 2001 The actual investment strategies of four internationalequity portfolio managers shown on the gure generally follow this upward trendof the share of US equities in the portfolio although the speci c strategies varysomewhat For international debt securities (bonds) the actual share of US issuedassets in total bonds issued in the international marketplace increased from about10 percent to about 30 percent as shown by the lower line on Figure 4

Given the relative performance of the US economy through the 1990s itmade sense to hold an increasing share of US assets in the portfolio Yet even asstock markets tumbled and the US economy stumbled from 1999 to 2001 the USshare of the global portfolio increased and the dollar appreciated further suggest-ing that global investors are not yet holding more US exposure than they preferWhat about the future

Future Sustainability of the US Current Account De cit

When the US economy slowed dramatically and entered a technical recessionin 2001 the current account de cit narrowed From the perspective of the national


income and product accounts the current account de cit and the savings-investment gap narrowed as domestic investment collapsed From the goods andservices perspective the slowdown and decline in US GDP growth slowed importgrowth dramatically In contrast from the perspective of international capitalmarkets portfolio managers continued to augment their portfolios with US assetseven as the nancing need of the current account de cit contracted so the dollarappreciated However the current account de cit appears set to resume its recenttrajectory of widening in the near future Relatively more robust US growthcontinues in large part because of the ldquonew economyrdquo base of improved produc-tivity and enhanced exibility The income asymmetry operating on imports thatare now 112 times exports means that the US current account de cit will widenagain Moreover the savings-investment gap has opened up as the scal surplus ofthe government narrowed rst as automatic stabilizers worked during the slow-down and then as policy changes in 2001 (tax cuts and increased spending) took hold

Looking forward the negative net international investment position will in-crease US exposure in the portfolio of the global investor probably also will risefurther At some point the trajectory for the current account will be unsustainableprobably because the share of US investments in the global investorrsquos portfolio willbe too high for diversi cation tastes (Mann 2002) With certain structural changesdiscussed in the next section the US demands on the global capital markets mightavoid reaching the threshold of unsustainability Otherwise the likely outcome is adollar depreciationmdashbut at what pace

Prospects for Structural Change National Saving Globalization of Servicesthe Euro

A rst place to look for structural changes that might affect the trajectory ofthe current account is in national savings Perhaps the government will increase its

Figure 4US Share of Holdings of Assets in International Bond and Equity Markets

Source Equity portfolio Economist portfolio pollInternational debt securities Bank for International Settlements


budget surplus position in the next few years as the economy strengthens Butthere appears little prospect for structural change in the household saving rate Thetrend decline in household savings is long-standing and even as the stock marketceased its stratospheric rise household savings did not rebound much The policyavenues to raise household savings are not well understood Consequently thedomestic savings-investment imbalance is likely to reemerge and remain so long asUS domestic investment stays strong

A second place to look for a structural change to affect the trajectory of thecurrent account is the income asymmetry Global trade in services appears likely torise for several reasons as economies develop the services share in their GDP risesnew technology has made it easier to trade services and markets for services suchas transportation telecommunications nancial and business services have beenliberalized This rise in global trade in services might reduce or even reverse theincome asymmetry in trade that the US economy now experiences After all USexporters of services are highly competitive (McKinsey Global Institute 1992) Inaddition globalization of services might also enable foreign investors to holdstill-higher shares of US assets because liberalization of nancial markets abroadprobably would reduce the ldquohome biasrdquo that leads investors to invest such a highproportion of their portfolios in their home markets

Finally the introduction of the euro constitutes a major structural change inthe international currency landscape Ultimately this pan-European nancial assetis likely to share the spotlight with US dollarndashdenominated assets Indeed theintroduction of the euro in 1999 led to a brief increase in the share of euro-denominated instruments in international bond markets and a fall in US exposurein the equity portfolios of global investors But in 2000 and 2001 the risk-returnpro le seemed again to favor US investments and global investors dialed backtheir euro investments

No doubt some of the lack of sustained enthusiasm for the euro was due torelatively slower growth in the euro area But a related issue is the incompleteintegration of the euro nancial markets Euro area equity markets remain frag-mented which raises the transactions costs of obtaining European exposure As aresult capital in ows to Europe (which would cause the euro to appreciate) arelower than they otherwise might be (Bank for International Settlements 2000International Monetary Fund 2001 Mann and Meade 2002) The higher cost ofcapital associated with these incomplete markets could reduce the euro areagrowth rate by 05 percent (Heinemann and Jopp 2002) Conversely a moreintegrated nancial market in Europe as well as structural change to promotehigher productivity growth in Europe would contribute to net capital in ows fastereconomic growth and an appreciating euro all of which will tend to narrow theUS current account de cit

A Sentiment-Driven Depreciation of the DollarThe three structural factors just discussed will take time to affect the trajectory

of the US current account de cit if indeed the changes ever take place asoutlined In contrast global investors are assessing the return on US investments


on a daily basis including both credit risk and exchange rate risk against theirdesire to hold an internationally diversi ed portfolio The global investor maycontinue for a time to increase holdings of US assets particularly if the relativerisk-reward pro le holds up At some point however global investors will reach oreven go beyond the desired proportion of US assets in their portfolios If thecurrent account de cit continues to be large at a time when global investors nolonger wish to add more US assets to their portfolio the current account de citwill not be sustainable and an economic adjustment must occur

Several scenarios for such an adjustment are possible In one scenario thedollar exchange rate depreciates signi cantly perhaps as investors collectivelyreassess how valuable their US holdings have been or perhaps because of a changein the assessment of currency or earnings volatility In another possibly comple-mentary scenario US interest rates rise as corporations try to attract foreign anddomestic capital Both forces would narrow the trade de cit through changes inUS economic activity and changes in the dollar with the consequence of reduced ow of US assets into the international marketplace

Abrupt changes in currency values can be disruptive as the various interna-tional nancial crises have shown However the US economy is more insulatedthan most economies through its size the fact that most of its obligations aremarketable and are denominated in its own currency and because the internationalrole of the dollar underpins global demand for it Therefore in terms of damageit is likely that the brunt of the change in the dollar and the associated change inUS interest rates and demand would be borne as much by other countries as bythe United States

Moreover a dramatic one-time adjustment in the exchange or interest rateswill not address permanently the trajectory for the current account As long as theproductivity differential (with its impact on the dollar) and the income asymmetry(with its impact on trade ows) continue the dollar will appreciate again and thecurrent account de cit will resume expanding sowing the seeds of another sus-tainability episode as indeed the roller coaster ride of the US dollar in foreignexchange rates since 1973 suggests

Conclusion

Continuing US current account de cits mean that the net internationalinvestment position of the US economy is increasingly negative The globalinvestment community seems willing and able to hold suf cient US assets in itsportfolios to nance these de cits for now But global investors will not expand theshare of their portfolios that is in US assets forever

The inevitable long-term adjustment to a smaller US current account de citcan come either by a set of quick response events or by structural change andpolicy design The most likely quick response event is that global investors reach apoint where they are no longer willing to increase the share of US assets that they


hold in their portfolios and a declining exchange value of the dollar will be theprincipal equilibrating force reducing the current account de cit

The structural and policy changes that could combine to change the wideningtrajectory of the current account de cit include scal discipline and more robusthousehold saving in the US economy more rapid economic growth abroadunderpinned by higher productivity growth more liberalized domestic and globalmarkets for services and more deeply integrated euro nancial markets Theadjustment process toward a lower US current account balance is likely to be farsmoother if it is carried out through these kinds of reforms in a relatively benignenvironment rather than through a series of disruptive sentiment-driven depreci-ations in the exchange value of the US dollar

References

Alquist Ron and Menzie D Chinn 2002 ldquoPro-ductivity and the Euro-Dollar Exchange RatePuzzlerdquo NBER Working Paper 8824 NationalBureau of Economic Research

Baily Martin N 2002 ldquoThe New EconomyPost Mortem or Second Windrdquo Journal of Eco-nomic Perspectives Spring 162 pp 3ndash22

Baily Martin N and Jans Gersbach 1995 ldquoEf- ciency in Manufacturing and the Need forGlobal Competitionrdquo Brookings Papers on Eco-nomic Activity Microeconomics 1 pp 307ndash47

Bank for International Settlements 2000 70th

Annual Report Chapter 7 JuneBank for International Settlements 2002

ldquoCentral Bank Survey of Foreign Exchange andDerivatives Market Activity in 2001rdquo March

Branson William and Dale W Henderson1985 ldquoThe Speci cation and In uence of AssetMarketsrdquo in Handbook of International EconomicsVolume 2 Ronald W Jones and Peter B Keneneds New York Elsevier North-Holland pp749ndash805

Chinn Mezie and Eswar S Prasad 2000ldquoMedium-Term Determinants of the Current Ac-counts in Industrial and Developing CountriesAn Empirical Explorationrdquo NBER Working Pa-per 7581

Cline William R 1989 United States ExternalAdjustments and the World Economy WashingtonDC Institute for International Economics

Cooper Richard 2001 ldquoIs the US CurrentAccount De cit Sustainable Will It Be Sus-

tainedrdquo Brookings Papers on Economic Activity 1pp 217ndash26

De Brower Gordon 2001 Hedge Funds inEmerging Markets Cambridge Cambridge Uni-versity Press

Deardorf Alan V et al 2001 ldquoForecastingUS Trade in Servicesrdquo in Services in the Interna-tional Economy Robert M Stern ed Ann ArborUniversity of Michigan Press p 53

Dee Phillipa and Kevin Hanslow 2001 ldquoMul-tilateral Liberalization of Services Traderdquo in Ser-vices in the International Economy Robert M Sterned Ann Arbor University of Michigan Press pp118ndash39

Dornbusch Rudiger 1976 ldquoExpectations andExchange Rate Dynamicsrdquo Journal of PoliticalEconomy 846 pp 1161ndash176

Feenstra Robert C and Clinton R Shiells1997 ldquoBias in US Import Prices and Demandrdquoin The Economics of New Goods Timothy F Bresna-han and Robert J Gordon eds Chicago Uni-versity of Chicago Press pp 249 ndash76

Frenkel Jacob A and Michael L Mussa 1985ldquoAsset Markets Exchange Rates and the Bal-ance of Paymentsrdquo in Handbook of InternationalEconomics Volume 2 Ronald W Jones and PeterB Kenen eds New York Elsevier North-Holland pp 679ndash747

Freund Caroline 2000 ldquoCurrent Account Ad-justment in Industrial Countriesrdquo Federal Re-serve Board of Governors International FinanceDiscussion Papers 692 December

Gagnon Joseph 1996 ldquoNet Foreign Assets


and Equilibrium Exchange Rates Panel Evi-dencerdquo Federal Reserve Board of GovernorsInternational Finance Discussion Papers 574

Gale William G and John Sabelhaus 1999ldquoPerspectives on the Household Savings RaterdquoBrookings Papers on Economic Activity 1 pp 181ndash224

Gould David 1994 ldquoImmigrant Links to theHome Country Empirical Implications for USBilateral Trade Flowsrdquo Review of Economics andStatistics May 762 pp 302ndash16

Grubel Herbert G 1968 ldquoInternationally Di-versi ed Portfolios Welfare Gains and CapitalFlowsrdquo American Economic Review December584 pp 1299ndash314

Heinemann Friedrich and Mathias Jopp2002 The Benets of a Working European RetailMarket for Financial Services Report to European Fi-nancial Services Round Table Bonn Institut furEuropaische Politick Europa Union VerlagGmbH

Helkie William H and Peter Hooper 1988ldquoThe US External De cit in the 1980s An Em-pirical Analysisrdquo in External Decits and the DollarThe Pit and the Pendulum Ralph C Bryant Ger-ald Holtham and Peter Hooper eds Washing-ton DC Brookings Institution Chapter 2

Helpman Elhanan 1997 ldquoRampD and Produc-tivity The International Connectionrdquo NBERWorking Paper Series 6101

Hooper Peter and Catherine L Mann 1989ldquoThe Emergence and Persistence of the USExternal Imbalance 1980ndash1987rdquo PrincetonUniversity Department of Economics Interna-tional Finance Section Princeton Studies in In-ternational Finance No 65 October

Hooper Peter Karen Johnson and Jaime Mar-quez 1998 ldquoTrade Elasticities for G-7 Coun-triesrdquo Federal Reserve Board of Governors In-ternational Finance Discussion Papers 609

Houthakker Hendrick S and Stephen P Ma-gee 1969 ldquoIncome and Price Elasticities inWorld Traderdquo Review of Economics and StatisticsMay 51 pp 111ndash25

Isard Peter and Lois Stekler 1985 ldquoUS In-ternational Capital Flows and the Dollarrdquo Brook-ings Papers on Economic Activity 1 pp 219ndash36

International Monetary Fund 2000 World Eco-nomic Outlook Washington DC InternationalMonetary Fund

International Monetary Fund 2001 ldquoRecentStructural Changes in European GovernmentSecurities Marketsrdquo in International Capital Mar-kets Developments Prospects and Key Policy IssuesWashington DC International MonetaryFund pp 99 ndash110

Jensen J Bradford and Nathan Musick 1996ldquoTrade Technology and Plant Performancerdquo

ESAOPD 96-4 US Department of CommerceEconomics and Statistics Administration February

King Harlan 2001 ldquoThe International Invest-ment Position of the United States at Yearend2000rdquo Survey of Current Business July p 7

Knight Malcom and Fabio Scacciavillani1998 ldquoCurrent Accounts What is their Rele-vance for Policy Makingrdquo International Mone-tary Fund Working Paper WP9871

Krugman Paul R 1985 ldquoIs the Strong DollarSustainablerdquo in The US Dollar Recent Develop-ments Outlook and Policy Options Kansas CityFederal Reserve Bank of Kansas City pp 103ndash55

Krugman Paul and Richard Baldwin 1987ldquoThe Persistence of the US Trade De citrdquoBrookings Papers on Economic Activity 1 pp 1ndash43

Landefeld J Steven and Ann M Lawson1991 ldquoValuation of the US Net InternationalInvestment Positionrdquo Survey of Current BusinessMay 715 pp 40ndash49

Levich Richard M 1998 International Finan-cial Markets Prices and Policies Boston IrwinMcGraw-Hill

Lewis Karen K 1995 ldquoPuzzles in Interna-tional Financial Marketsrdquo in The Handbook ofInternational Economics Volume 3 Gene Grossmanand Kenneth Rogoff eds New York ElsevierNorth-Holland pp 1913ndash971

Lewis Karen K 1999 ldquoTrying to ExplainHome Bias in Equities and Consumptionrdquo Jour-nal of Economic Literature June 372 pp 571ndash608

Mann Catherine L 1991 ldquoStructural Changeand Prospects for Sustained Improvement in theUS External Balancerdquo Contemporary Policy IssuesApril 92 pp 50 ndash58

Mann Catherine L 1998 ldquoGlobalization andProductivity in the United States and Germanyrdquoin Globalization Technological Change and LaborMarkets Stanley W Black ed Boston KluwerAcademic Publishers pp 17ndash44

Mann Catherine L 1999 Is the US TradeDecit Sustainable Washington DC Institutefor International Economics

Mann Catherine L 2002 ldquoHow Long theStrong Dollarrdquo Institute for International Eco-nomics International Economics Policy Briefsforthcoming

Mann Catherine L and Ellen E Meade 2002ldquoHome Bias Transactions Costs and Prospectsfor the Eurordquo Asset Price Bubbles ConferenceFederal Reserve Bank of Chicago April

Marquez Jaime 2002 Estimating Trade Elastic-ities Boston Kluwer Academic Press Forthcoming

Marquez Jaime and Neil R Ericsson 1993ldquoEvaluating Forecasts of the US Trade Bal-ancerdquo in Evaluating Policy Regimes New Researchin Empirical Macroeconomics Ralph C BryantPeter Hooper and Catherine L Mann eds


Washington DC Brookings Institution pp671ndash732

Marris Stephen 1985 ldquoDe cits and the Dol-lar The World Economy at Riskrdquo Institute forInternational Economics Policy Analyses in In-ternational Economics November

Marston Richard 1987 ldquoReal Exchange Ratesand Productivity Growth in the United Statesand Japanrdquo in Real-Financial Linkages in the OpenEconomy Sven Arndt and J David Richardsoneds Cambridge MIT Press pp 71ndash96

Mataloni Raymond Jr 2000 ldquoAn Examina-tion of the Low Rates of Return of Foreign-Owned US Companiesrdquo Survey of Current Busi-ness March 803 55ndash73

McKinsey Global Institute 1992 Services SectorProductivity Washington DC McKinsey GlobalInstitute October

Meade Ellen E and Charles P Thomas 1993ldquoUsing External Sustainability to Model the Dol-larrdquo in Evaluating Policy Regimes New Research inEmpirical Macroeconomics Ralph C Bryant PeterHooper and Catherine L Mann eds Washing-ton DC Brookings Institution pp 769ndash92

Milesi-Ferretti Gian Maria and Assaf Razin1996 ldquoCurrent Account Sustainabilityrdquo Prince-ton University Department of Economics Inter-national Finance Section Princeton Studies inInternational Finance No 81 October

Obstfeld Maurice and Kenneth Rogoff 1995ldquoThe Intertemporal Approach to the CurrentAccountrdquo in The Handbook of International Eco-nomics Volume 3 Gene Grossman and Kenneth

Rogoff eds New York Elsevier North-Hollandpp 1731ndash799

Obstfeld Maurice and Kenneth Rogoff 2000ldquoPerspectives on OECD Economic IntegrationImplications for US Current Account Adjust-mentrdquo Global Economic Integration Opportunitiesand Challenges Kansas City Federal ReserveBank of Kansas City pp 168ndash209

Organization for Economic Cooperation andDevelopment (OECD) 1997 The World in 2020Towards a New Global Age Paris OECD

Rosen Howard and J David Richardson2001 ldquoWhy Global Engagement Matters MostrdquoWashington DC Institute for InternationalEconomics September

Tesar Linda and Ingrid Werner 1998 ldquoTheInternationalization of Securities Markets Sincethe 1987 Crashrdquo in Brookings-Wharton Papers onFinancial Services Robert Litan and Anthony San-tomero eds Washington DC Brookings Insti-tution pp 281ndash371

Tille Cedric Nicolas Stoffels and Olga Gor-bachev 2001 ldquoTo What Extent Does Productiv-ity Drive the Dollarrdquo Federal Reserve Bank of NewYork Current Issues in Economics and Finance Au-gust 78 pp 1ndash6

Ventura Jaume 2001 ldquoA Portfolio View of theUS Current Account De citrdquo Brookings Paperson Economic Activity 1 pp 241ndash53

Wren-Lewis Simon and Rebecca L Driver1998 ldquoReal Exchange Rates for the Year 2000rdquoWashington DC Institute for InternationalEconomics Policy Analyses in International Eco-nomics 54


the sustainability of the current account de cit and the associated in ow of capitalThe large stock of nancial obligations implies ows of income payments andreceiptsmdashinterest dividends and the likemdashthat must be paid out of the economyrsquoscurrent production and that could get large enough to reduce current consump-tion and investment Moreover even a large economy such as the United Statesmust consider the implications of a change in foreign investor sentiment about thedesirability of holding a large share of US assets in their portfolios and ofcontinuing to provide the net in ow of nancial capital

Figure 1 shows the current account de cit and its main component the goodsand services trade balance as a share of US GDP since 1973 Table 1 shows themagnitude in dollar terms for selected years of these two main balances along withthe remaining two components of the current account net income payments onthe net international investment position and unilateral transfers (such as US

Table 1US External Balance and Components Selected Years (billions of dollars)

1980 1985 1990 1995 2001

Current Account 23 21182 2790 21058 23934Goods and Services 2194 21219 2809 2964 23583Net Income 301 257 286 246 144Net Unilateral Transfers 283 2220 2267 2341 2495

Source Bureau of Economic Analysis Department of Commerce httpwwwbeadocgov Reviseddata 6202002

Figure 1Overview of the External De cits and the Dollar

Source External Balances Bureau of Economic Analysis Department of Commerce httpwwwbeadocgov Real exchange rate Federal Reserve Board httpwwwfederalreservegov

















1tradedeficit 5

privateinvestment 1























Imports and US GDP



























1980 1985 1990 1995 2000 2001



















































Conclusion






References




















































































1tradedeficit 5

privateinvestment 1























Imports and US GDP



























1980 1985 1990 1995 2000 2001



















































Conclusion






References






















































































Imports and US GDP



























1980 1985 1990 1995 2000 2001



















































Conclusion






References





























































































1980 1985 1990 1995 2000 2001



















































Conclusion






References




















































































































Conclusion






References







































































References





































































perspectives on the u. s. current account deficit and sustainability14.54/handouts/mann.pdf ·...

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