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What issues arise when some countries
have sustained imbalances on the
current account?
Sheila Pugh,
Ipswich School
To see more of our products visit our website at www.anforme.co.uk
What issues arise when some countries
have sustained imbalances on the
current account?
Sheila Pugh,
Ipswich School
To see more of our products visit our website at www.anforme.co.uk
What are global imbalances
And why do they matter
so much?
• C “Global imbalances helped to fuel the financial crisis. And today they
threaten the sustainability of the recovery of global demand.” Mervyn King,
Governor of the Bank of England (2011).
• C The term global imbalances is used to describe the large current account
surpluses and deficits that emerged in the world after 1997.
•C
In 2007, on the eve of the global crisis and subsequent recession, Spain,
Australia, the US and the UK all had large current account deficits as a
percentage of GDP.
•C
But, huge surpluses had developed in the oil-exporting countries, China
and other East Asia countries, Germany and Japan.
What can cause
global imbalances (1)?
• C Global imbalances have been described as probably the most complex
macroeconomic issue facing economists and policy makers.
• C They can be caused by many different factors and economists do not know
or agree on all the causes.
• C There is also disagreement on the impact of the imbalances and hence
on whether policies are needed to reduce them.
• C In A level Economics we normally focus on changes in competitiveness
and changes in aggregate demand as causes of current account
surpluses and deficits.
• C But current account imbalances also reflect differences between a
country’s total savings and total investment, which is a key to
understanding the emergence of large world imbalances.
What can cause
global imbalances (2)?
• C The national income accounts show that the difference between a country’s
imports and exports is equal to the difference between total income and
total spending.
• C Another way of looking at this is to focus on the counterpart of the current
account which is the financial account.
• C Inflows on the financial account consist of foreigners’ purchases of
domestic financial assets.
• CDomestic residents’ purchases of
foreign financial assets are the outflows.
What can cause
global imbalances (3)?
• C Overall the balance of payments must balance.
• C A surplus on the current account must be offset by an equal and opposite
deficit on the financial account.
• C A deficit on the financial account represents net lending abroad by the
residents of a country which they will be doing if their spending is less
than their income, or if their saving is greater than their investment.
• C Conversely, if a country is saving less than it is investing, then they must
be funding the investment in part by borrowing from abroad and running
a surplus on the financial account.
• C This in turn means that the current account must be in deficit.
A saving’s glut?
Global imbalances
before the recession (1)
• C Ben Bernanke, now chairman of the US Federal Reserve Bank, coined the
term ‘a global saving glut’ in 2005.
• C He argue the US deficit was caused primarily by an increase in savings in
emerging economies, especially China.
• CThese savings were surplus to their investment needs
and so used to buy US financial assets.
• CThe net inflow of funds to the US led to a
surplus on the financial account and so a
deficit on the current account.
A saving’s glut?
Global imbalances
before the recession (2)
• C How would trade flows have actually responded to the change on the
financial account?
• C The adjustment takes place through a rise or fall in the exchange rate.
• C Higher Chinese demand for US financial assets would
shift the demand for dollars to the right, causing the
yuan/dollar exchange rate to rise.
• C The appreciation in the dollar makes exports more expensive and imports
cheaper thus pushing the current account into deficit.
A saving’s glut?
Global imbalances
before the recession (3)
• C Between 1995 and 2009 the divergence between savings and investment
appears to have been mainly due to an increase in the savings rate in
surplus countries rather than to changes in investment.
• C Savings have been high in China for a variety of reasons.
• C Households have to save to fund health, education and pensions.
• C Also, a poorly-developed financial system also limits the scope for
households to borrow and so increases the need for saving.
• C However, the main increase in saving up to 2007 came from Chinese
companies which were earning huge profits which were surplus to their
investment needs and which they did not have to pay out as dividends.
A saving’s glut?
Global imbalances
before the recession (4)
• C A saving’s glut or surplus was not the only reason for the emergence of
large current account surpluses by 2007.
• C Governments or central banks also sell domestic currency in order to
purchase foreign exchange.
• C This shifts the supply of domestic currency to the right and results in a fall
in the exchange rate.
• C Exports are mow cheaper and imports more expensive and the current
account surplus increases.
• C Asian countries have chosen to buy US government securities to hold as
foreign exchange reserves thus further contributing to the inflow of
foreign funds to the US.
• C Also, current account surpluses have been due to a pursuit of export-led
growth by deliberately maintaining a low exchange rate to make exports
more competitive.
Low world interest rate
and the ‘search for yield
• C Have the imbalances been caused by some countries pursuing surpluses
or can the finger be pointed at the US and others for running deficits?
• C The US budget deficit and high levels of US household consumption have
contributed by causing total US spending to exceed income.
• C This generates a need for borrowing from overseas, a surplus on the
financial account and thus a current account deficit.
• CHowever, the emergence of global
imbalances was accompanied by a
fall in world interest rates.
Low world interest rate
and the ‘search for yield
• C If higher consumption in deficit countries had been the driving forces
behind world imbalances then savings would have shifted to the left and
interest rates risen.
• C The fact that interest rates fell suggests that the driving force was an
increase in savings in surplus countries which shifted the supply of savings
to the right.
• C Many argue that the high demand for securities from surplus countries
plus the low interest rates led banks’ ‘search for yield’ to achieve higher
returns with a disregard for risk .
• C Thus global imbalances may have contributed to the financial crisis.
Global imbalances
since 2007
• C Most countries’ current account imbalances narrowed in the worldwide
recession which began in 2008.
• C In deficit countries such as the US and UK the main factors at work were
higher household savings rates as house prices fell, consumers began
repaying debt and increasing their precautionary savings.
• C Lower household real incomes led to less demand for imports and in the
UK a very large depreciation of the pound.
• C The fall in world trade also reduced current account surpluses with a
further factor being an appreciation in China’s exchange rate.
Imbalances and
recovery from recession
• C Despite the narrowing of imbalances they remain large so how might they
impede recovery?
• C Recovery from a recession normally requires aggregate demand to
increase.
• C This must come from higher consumer expenditure, higher investment,
increases in government expenditure or increased net exports.
• C Since household savings rates have risen in deficit countries, consumer
expenditure is unlikely to drive recovery.
• C This has also contributed to low business confidence and depressed
investment.
• C Also, governments are trying to reduce budget deficits which negatively
impacts aggregate demand.
• C This leaves foreign demand and an increase in exports as the main hope
for an engine of growth to pull the economy out of recession.
Imbalances and
recovery from recession
• C If deficit countries hope to ‘rebalance’ their economies towards exports
then their current account deficits must fall.
• C But this implies that surplus countries must allow their current account
surpluses to shrink as they import more from the deficit countries.
• C One way this rebalancing could happen is for exchange rates to fall in
deficit countries.
• C But this is not possible for Eurozone deficit countries which trade mainly
with other Eurozone economies.
• C Alternatively, or additionally, surplus countries could spend more,
especially on consumption, save less and raise their demand for imports.
Imbalances and
recovery from recession
• C The danger comes when ex ante or planned spending and saving levels in
different countries do not match up.
• C Suppose deficit countries need to reduce their current account deficits
because households are saving more and the governments are reducing
their budget deficits.
• C Suppose at the same time surplus countries do not wish to reduce their
current account surpluses.
• C World ‘planned’ imbalances will not sum to zero.
• C They will be brought into equilibrium by a fall in world aggregate demand,
a fall in output and a consequent narrowing of both current account
deficits and surpluses.
• C The recession will persist, at least in the deficit countries.
Conclusions
• C Current account imbalances peaked in 2007 and mainly reflected an
increase in savings in surplus countries.
• C The saving’s glut depressed world interest rates and some economists
argue that the resulting ‘search for yield’ enabled or fuelled the financial
crisis.
• C World imbalances are now smaller but remain significant.
• C They may impede recovery from recession and cause incomes to fall if
deficit countries attempt to reduce their current account deficits, but at the
same time surplus countries resist a diminishing of their surpluses.