December 27, 2009
The Prospects for Global Imbalances: A View from the IMF
Following up on recent posts (, , , ,  ) Here's another take on the prospects for resolving global imbalances, from Olivier Blanchard and Gian Maria Milesi Ferretti, "Global Imbalances: In Midstream?" Staff Position Note 09/29 (Dec. 22, 2009):
IV.B. Lower Global Imbalances in the Future
What will happen in the future depends on how long the factors we just listed will be in play [oil price decline, asset price busts, increase in home bias, the hit to durable consumption and investment goods demand].
Below is reproduced the IMF World Economic Outlook's October 2009 forecast for current account balances.
Figure 7 from Blanchard and Milesi Ferretti (2009).
Blanchard and Milesi Ferretti continue:
Clearly, some of them are likely to be transitory. The large output gaps in most countries will eventually disappear, at a rate determined by the strength of the recovery. And in most countries, the sharp increase in private saving is likely to unwind as uncertainty is reduced, and income and asset prices recover; so are, in the opposite direction, the various fiscal stimuli, which will have to be phased out over time.
But some of the changes are likely to be long lasting, if not permanent:
- Private saving is projected to be generally higher than before the crisis. This is because, even as output returns to its potential level, asset prices, and thus wealth, may not return to pre-crisis levels any time soon. The increase in saving is expected to be larger in the United States, where private saving was unusually low before the crisis, and where the crisis has probably durably affected saving behavior. To the extent that U.S. saving is indeed more affected than in other countries, this implies a reduction in the U.S. current account deficit, and lower global imbalances.
- Investment rates are likely to be significantly lower in a number of countries than they were before the crisis. To the extent that tighter financial regulation increases the cost of intermediation, the cost of capital will increase. In the countries that experienced housing booms pre crisis, housing investment is likely to be low for some time. To the extent that housing price booms were associated, in many 14 countries, with large current account deficits (from the U.S. to Spain and Ireland), this also implies lower deficits in those countries, and lower global imbalances.
- Risk premia on cross border flows to many debtor countries have risen, implying a higher cost of capital. While these premia are lower now than at the peak of the crisis, they are likely to remain higher than pre-crisis levels, and lead to a more modest recourse to external finance. This is also likely to limit the scope for running large current account deficits, and thus, again reduce global imbalances.
- A factor that has not played out much during the crisis but is likely to be important in the near future is the reserve behavior of emerging market countries. There are two reasons for this. We are seeing the first now: the worry about large capital inflows is leading emerging economies, especially in Asia, to limit exchange rate appreciation and accumulate further reserves. And more generally, the crisis can be read by many countries as suggesting that more rather than less reserves are desirable.
So what do these factors imply for the unwinding of global imbalances? If we go back to past policy advice and the main conclusions of the multilateral consultations, one important adjustment -- the increase in U.S. private saving -- is under way. However, other parts of the global external adjustment process are not in place yet: In response to the crisis, US fiscal deficits have increased significantly, and will need to decline substantially in the future; current account adjustment in China, while significant in 2009, may turn out to be largely temporary, particularly if the renminbi is not allowed to appreciate; and a number of other emerging market countries are still running surpluses and accumulating foreign reserves.
So how will global imbalances evolve? It is useful to go through a number of scenarios.
The authors outline three scenarios: (1) "ideal", with smooth upward adjustment in US public saving and downward adjustment in China and other East Asian countries; (2) partial adjustment in China and East Asia toward domestic demand and smaller budget deficits in US; (3) partial adjustment in China and East Asia toward domestic demand, but phase out US budget deficits. Figure 7, the WEO forecast, does not match either of these scenarios, but does incorporate elements of Scenario 3. Premier Wen Jiabiao's recent remarks  suggest that Scenario 1 is not terribly likely, but in my view, it's more important to see what occurs rather than what is said, when it comes to Chinese policy.
On a related note, see Helmut Reisen's take on whether a large RMB revaluation is necessary. Dani Rodrik argues in favor of subsidizing tradables, rather than currency undervaluation, as a means of reorienting the Chinese economy.
Posted by Menzie Chinn at December 27, 2009 07:30 PMdigg this | reddit
"If we go back to past policy advice and the main conclusions of the multilateral consultations, one important adjustment -- the increase in U.S. private saving -- is under way."
I believe you need to look at private savings more like this. The domestic private rich are still saving in the USA, but most of the private, domestic lower and middle class have stopped going into debt to the private rich whether domestic or foreign.
Posted by: Get Rid of the Fed at December 28, 2009 11:26 AM
The common assumption in all these complicated discussions is that the U.S. government will remain passive. Non-intervention is assumed. Why? Just because that is the policy prescription that follows from adherence to Free Trade. Crises have a way of overturning traditions.
I know, you learned in your first economics course that protectionism as historically practiced (discrimination by specific product, such as steel or textiles) is the only alternative to free trade. Of course, you know that is wrong, if you think about it. The U.S. could estalish a system that discriminates against ALL U.S. imports manufactured in the countries that are creating 2/3rds of the U.S. trade deficit. As I said, when a problem is serious enough some people begin to think outside the box.
I believe that the U.S. must act so as to reduce our large trade deficit. Why shouldn't the U.S. government act to manage trade so as to benefit the U.S. economy as a whole?
Membership in the World Trade Organization is voluntary. Each soverign nation has the right to set the rules under which imports enter the country.
Posted by: ReformerWRay at December 28, 2009 12:27 PM
Does silence give consent? I would like to believe that lack of response to the above post is due to widespread agreement that the Federal government should move off its passive position and begin to search actively for actions it can take to reduce the size of the U.S. trade deficit and by that means move world trade closer to balance. I hate the notion that nothing can be done; that we are just the victims of forces over which we have no control.
Posted by: ReformerRay at December 28, 2009 07:42 PM
Whilst reading this report on imbalances,the manifesto 1930 of Pr Murchison of the North Carolina University in 1930 is coming to my mind ,the state of duress in the US economy stems from the reserve system and the investments trusts.
The IMF is not dealing with this subject.
During the same reading I remembered that in 1930 all hopes for a better a economic order (better financial balance) were pined on the creation of the Bank of International Settlement.
As Private and corporate debts may be decreasing the imbalances may slowly be, temporarily decreasing.
Posted by: ppcm at December 29, 2009 01:02 AM
I think Michael Pettis went through the ways the trade imbalance must get resolved if US savings rates rise much more consistently in a piece for the Carnegie Endowment. His conclusion seems to be that the better outcomes (higher Chinese consumption or global investment in line with the increase in US savings) are unlikely, and that the distribution of the worse outcomes will depend of struggles over trade. It is not a terribly optimistic piece. (You can find his piece at http://www.carnegieendowment.org/publications/index.cfm?fa=view&id=24219)
Posted by: AZ at December 29, 2009 03:32 AM
From the above post: "the distribution of the worse outcomes will depend (upon) struggles over trade. It is not a terribly optimistic piece. (You can find his piece at "
The struggles over trade should be minimized by the U.S. government inventing an action that they can take which will reduce the U.S. trade deficit and at the same time be somewhat acceptable to the governments of China, Japan, Germany, Canada and Mexico.
Posted by: ReformerRay at December 29, 2009 12:02 PM
In order to balance the massive trade deficits on an average basis (of course you will have cyclical and seasonal variations in the short term) the US needs to address the structural trade problems.
One principle problem is that US corporations planning on a short term basis are taking advantage of labor arbitrage and other cost benefits by shifting manufacturing overseas. This is a very contractionary force because US incomes are cancelled in manufacturing and also the taxation base is diminshing. American corporations need to be limited in how much they can invest abroad.
Posted by: Danny at December 31, 2009 06:46 PM
In the IMF chart the line labeled "Discrepancy" (the sum of all countries' reported current accounts?) moves by almost 1.5% of world GDP over 15 years.
What could cause that?
Or is such a large change simply implausible? Meaning, I presume, that actual 2010-2014 balances for one or more of the categories shown will have to be rather different from the projection shown?
Posted by: CK at January 1, 2010 03:06 AM