Global Current Account Adjustments: A Decomposition

Michael Devereux and Amartya Lahiri

No 750, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: In the last five years the international macroeconomics literature has become increasingly concerned with global current account imbalances, with particular focus on the size and persistence of the US current account deficit. While much of the recent literature on global imbalances (e.g. Caballero and Gourinchas 2005, Engel and Rogers, 2005 ) has attempted to rationalize the recent surge in the US current account deficit within theoretical settings, there has been little effort devoted to providing a quantitative accounting of the observed path of capital flows. In this paper we attempt to answer precisely this question. We follow the recent methodology developed by Cole and Ohanian (2004, 2005), Chari et al. (2004) etc. In particular, we construct a model of the world economy comprised of three regions – the US, EU/Japan and Emerging Markets. The model is the standard one-sector neoclassical growth model with production and investment. We then run actual data through the optimality conditions of the model and back out the ex-post deviations (or “wedges†) in these conditions relative to optimality. We call these measured deviations “wedges†. The model generates three wedges – two optimality wedges and one productivity wedge. We find that in order to rationalize the data, the neoclassical model demands a combination of time varying wedges in the intertemporal Euler wedge as well as variations in the productivity wedge. However, from a purely accounting standpoint, the productivity wedge is quantitatively much larger than the mean level of the Euler wedge during our sample period. This leads us to conclude that explanations such as Caballero-Gourinchas (2005), which imply time variation in the Euler wedge can at best, be a very partial explanation of the growing global imbalance. Explanations which center on productivity differences (like the older absorption view of current account determination) are quantitatively more important.

Keywords: current account; global imbalance (search for similar items in EconPapers)
JEL-codes: F1 F2 (search for similar items in EconPapers)
Date: 2006
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Journal Article: Global current account adjustment: a decomposition (2006)
Working Paper: Global current account adjustment: a decomposition (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed006:750

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