February 16, 2006
Open Economy Macro in the 2006 Economic Report of the President
Beryl Sprinkel meets Ben Bernanke
There is no problem with the balance of payments because it's always balanced. [a paraphrase of a quote of Beryl Sprinkel, CEA Chairman, 1985-89]
By economic definition, a country's current and capital account balances must offset one another. Therefore, the U.S. current account deficit was matched by a capital account surplus of $668 billion (including $85 billion in net statistical discrepancies within the capital account, which are included in part to ensure the accounts sum to zero). [page 125, Economic Report of the President, 2006]
The Economic Report of the President is a publication with dual purposes. The first is pedagogic, laying out basic economic principles for a general audience. The second is didactic, seeking to persuade the undecided. This year's international finance chapter is provocatively titled "The Capital Account Surplus", to remind readers that, in an accounting sense, Beryl Sprinkel's characterization is correct. Define CA as the current account, KA (technically termed the capital and financial account) as net capital inflows; then:
(where "==" means "identically equal to".) But there is another sense of the term "balance of payments", and the ERP completely sidesteps this definition. Break down the net capital inflows into private capital flows (KF) and official reserves transactions (ORT); then
which occurs when ORT is zero. Now the ERP does mention in Box 6-1 on page 129 that if one examines only the U.S. side of official reserves transactions, then it looks like we're in equilibrium according to this condition (only $3 billion net change in official reserves assets). This is the sense in which the 2006 ERP revisits Beryl Sprinkel's view of the balance of payments under floating exchange rates. Of course, if we lump into ORT both US and foreign official transactions (as the textbooks I have do), then the picture looks a lot different. The change in that category was about $415 billion. This point regarding the composition of flows to the US is the same that has been made by Nouriel Roubini and Brad Setser. While not incorrect, the authors of the ERP have not been fully transparent in their discussion of capital flows, and what constitutes "official reserve transactions". In addition, it is important to recall that private capital flows are, by definition, private in that they do not pertain to central bank or monetary authority transactions. As Martin Feldstein has pointed out, some unknown proportion of the private capital flows are undertaken by government and quasi-governmental enterprises. Hence, one should be a little cautious about taking the remainder of the capital flows as a vote in favor of the U.S. economy's prospects.
Here's another interesting aspect of the chapter. One virtue of the ERPs of the past has been the caveats that are usually attached to strong assertions of economic behavior. But in this edition, there is an uncharacteristically unhedged assertion on page 146:
The interdependence of the global financial system implies that no one country can reduce its external imbalance through policy action on its own. Instead, reducing external imbalances requires action by several countries. Specifically, at least four steps may help to reduce these imbalances.But this is not true, even taking the chapter's premises at face value. In box 6-3 assessing "the link between fiscal and trade deficits", the authors cite favorably the Fed's estimate of an elasticity between fiscal and trade deficits of 0.20. They don't note that this result from a calibrated model (Sigma) is at the low end of the estimates. The OECD macroeconometric model incorporates an elasticity of about 0.40, while the IMF's calibrated model implies an elasticity of 0.50.
Posted by Menzie Chinn at February 16, 2006 07:05 AMdigg this | reddit
I can not open the attachment to the Economic Report of the President I really want a copy of the book.
Posted by: Aaron Wellington at February 16, 2006 05:15 PM
Sorry to ask a dumb question but does the elasticity between the fiscal and trade deficits vary with the level of gov't spending vs gdp? Also, is the elasticity different with how the gap is closed, e.g. a reduction in spending vs an increase in taxes?
Posted by: Frank at February 17, 2006 05:30 AM
Aaron Wellington: Not sure how to fix your problem. It's a standard pdf file. Back-up: in the old (pre-internet) days, if you called the White House and asked for the publications office, you could get a copy. Or you can call the Government Printing Office, and request a copy.
Frank: These estimated sensitivities of the percentage point change in current account deficit to percentage point change in budget deficit is calculated as a change around a baseline. Most of the recent analyses have focused on a change resulting from a tax increase, for obvious reasons. I have more discussion of this issue in this post
Posted by: menzie chinn at February 17, 2006 08:17 AM
Lets see if I have this correct (according to Beryl Sprinkel):
Debt is equity,
Spending is saving.
I must be really, really rich then.
Posted by: Cyberike at February 17, 2006 10:51 AM
This administration relies a lot on George Orwell...
Posted by: outsider at February 18, 2006 12:29 AM
"Spending is saving": This is not far from the truth. We do not save by maintaining huge deposits at local banks. We save by taking advantage of sales at a discount. We buy things only if they are on sale at a discount of at least 10%-25%. If these discounts are properly accounted for, it would turn out that we are the greatest saver nation on earth. The savings conondrum is nothing else than obsolete tools to measure savings. As usual, Beryl Sprinkel is not only right, but he is way ahead of the academic economists in these matters.
Posted by: Robert Sczech at February 20, 2006 07:25 PM