How Expected Inflation Distorts the Current Account and the Valuation Effect

Sauré, Philip and Philipp Herkenhoff
Authors registered in the RePEc Author Service: Philip Ulrich Sauré

No 15469, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We show that the current account balance (CA) is systematically distorted by an inflation effect, which arises because income on foreign-issued 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 effects (search for similar items in EconPapers)
JEL-codes: F30 F32 (search for similar items in EconPapers)
Date: 2020-11
New Economics Papers: this item is included in nep-acc, nep-mac and nep-mon
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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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