Does the Current Account Still Matter?* Maurice Obstfeld University of California, Berkeley Richard T. Ely Lecture, American Economic Association Annual Meeting, Chicago, IL, January 6, 2012 Abstract Do global current account imbalances still matter in a world of deep international financial markets where gross two-way financial flows often dwarf the net flows measured in the current account? Contrary to a complete markets or “consenting adults” view of the world, large current account imbalances, while very possibly warranted by fundamentals and welcome, can also signal elevated macroeconomic and financial stresses, as was arguably the case in the mid-2000s. Furthermore, the increasingly big valuation changes in countries’ net international investment positions, while potentially important in risk allocation, cannot be relied upon systematically to offset the changes in national wealth implied by the current account. The same factors that dictate careful attention to global imbalances also imply, however, that data on gross international financial flows and positions are central to any assessment of financial stability risks. The balance sheet mismatches of leveraged entities provide the most direct indicators of potential instability, much more so than do global imbalances, though the imbalances may well be a symptom that deeper financial threats are gathering. *Department of Economics, 530 Evans Hall # 3880, University of California, Berkeley, CA 94720-3880 (e-mail: [email protected]). I thank Claudio Borio, Ralph Bryant, Jörg Decressin, Linda Goldberg, Pierre-Olivier Gourinchas, Robert Kollmann, Perry Mehrling, Gian Maria Milesi-Ferretti, and Hélène Rey for helpful discussions. I also thank Philip Lane and Gian Maria Milesi-Feretti for sharing their updated data on international asset and liability positions. Vladimir Asriyan and Gewei Wang provided expert research assistance. Financial support from the International Growth Centre, London School of Economics, and the Center for Equitable Growth, UC Berkeley, is acknowledged with thanks.1Are discrepancies between national exports and imports ever a legitimate cause for government concern or intervention? The question is as old as economic theory itself. Sixteenth-century English writers deplored the drainage of precious metals implied by deficits in foreign trade; as a result, the term “balance of trade” had entered into public discourse by the early seventeenth century.1 David Hume’s account in 1752 of the price-specie-flow mechanism, arguably the greatest set piece of classical monetary economics, vanquished for many years the mercantilist position that the perpetual accumulation of external wealth was both desirable and feasible. More than 250 years later, however, the foreign trade imbalances of national units – including even some that share common currencies – still figure prominently in debates over economic policy. We should not be surprised. Even in an ideal world free of economic frictions, foreign demand and supply conditions are constraints on the maximal welfare attainable by the national unit. Its government therefore faces incentives to manipulate those constraints. In simple neoclassical theory all countries gain from free trade, including balanced trade, but in a real world permeated with economic and political distortions, a government’s perceived short-run advantage may be enhanced by policies that enlarge the trade surplus. Such policies necessarily affect trading partners because a bigger surplus for one country requires correspondingly smaller ones for all the others. Of course, it is also quite common that government policies lead to larger deficits, and in theory, different distortions could result in absolute current account imbalances that are too small, rather than too big, compared to an efficient benchmark. 1 See Price (1905). On the evolving interpretation of the phrase, and its relation to what we now call the current account, see Fetter (1935).2Policies motivated by purely national advantage may well be collectively counterproductive if widely undertaken, which is why countries have sought to coordinate their trade and sometimes macroeconomic and financial policies. Economic frictions in goods markets and financial markets potentially increase the gains from policy cooperation, and they also can raise each country’s vulnerability to a range of internal and external shocks, as well as the strength of spillover effects abroad. While profitable to the private parties involved, some transactions between sovereign jurisdictions may exacerbate systemic vulnerabilities, and therefore are legitimate targets for policymakers’ attention. The recent global crisis and its troubled sequel have brought these possibilities into sharp relief. Some but not all observers link the origin of the crisis to the rapid increase in economic globalization that preceded it, especially financial globalization. Nearly everyone, however, acknowledges that stronger financial and trade linkages helped propagate the crisis across borders. Much contentious debate harks back to the debates of Hume’s day by focusing on the current account balance as a potential conduit for international shock transmission, or as a carrier of financial vulnerability. A country’s current account is the difference between its saving and its domestic investment, or, equivalently, between its exports of goods and services (including income receipts on assets held abroad) and its imports.2 The circumstantial evidence is that the crisis was preceded by historically large “global imbalances” in current accounts, including big deficits run by a number of industrial 2 This formula corresponds to Meade’s (1951, p. 7) definition of the “balance of trade.” Strictly speaking, any balance of unrequited transfers is added to this trade balance to compute the current account balance. The current account gets its name from its coverage of “current” as opposed to “capital” transactions. Its position today in United States balance of payments statistics owes to the recommendations of the Review3economies that subsequently came to grief (including the United States). Figure 1 shows how the dispersion of global current account imbalances grew from the late 1990s through 2006, the year before the onset of the global crisis. But is concern about current account imbalances still