How Expected Inflation Distorts the Current Account and the Valuation Effect

Philip Sauré and Philipp Herkenhoff ()
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Philipp Herkenhoff: Johannes Gutenberg University

No 2022, Working Papers from Gutenberg School of Management and Economics, Johannes Gutenberg-Universität Mainz

Abstract: We show that the current account balance (CA) is systematically distorted by an inflation effect, which arises because income on foreignissued debt is recorded as nominal interest in the currency of denomination. Since nominal interest includes compensations for expected inflation, increases in the latter must impact the CA. Guided by the relevant international accounting rules, we impute the inflation effect for 50 economies between 1991 and 2017. When adjusting for the inflation effect, the absolute value of yearly CAs drops by 0.13% of GDP on average. Over the full period, the reduction is sizable 22.85% of initial GDP for the average country (26.4% for the U.S.). As the flip-side of the CA distortions, the inflation effect contributes systematically to the well-known valuation effect of net foreign assets, of which about a twelfth is accounted for between 1991 and 2017 for the average country and well over half for the U.S.

Keywords: inflation; current account; valuation effect (search for similar items in EconPapers)
JEL-codes: F30 F32 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2020-10-09, Revised 2020-11-10
New Economics Papers: this item is included in nep-acc and nep-mac
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https://download.uni-mainz.de/RePEc/pdf/Discussion_Paper_2022.pdf First version, 2020 (application/pdf)

Related works:
Journal Article: How expected inflation distorts the current account and the valuation effect (2021)
Working Paper: How Expected Inflation Distorts the Current Account and the Valuation Effect (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:jgu:wpaper:2022

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