The importance of investment income and transfers in the current account: A new look on imbalances

Rolf Langhammer

No 48, Kiel Policy Brief from Kiel Institute for the World Economy (IfW Kiel)

Abstract: Over the last twenty five years, current account imbalances have been both rising over the trend and have become more volatile over the cycle. In boom times, imbalances expanded while in times of a cyclical downturn they shrank. A rising trend has been mainly explained with two developments: first, the increasing capacity and willingness of international financial markets to relax domestic savings constraints in financing domestic investment and consumption, and second constraints in domestic financial markets of some countries to efficiently absorb high domestic savings. The cyclical observation has often been derived from changes in trade flows and the 'slicing up' of the value added chain. For a number of supply and demand reasons, cross-border value-added chains grow during an upswing and shrink during downturns. Hence, the ups and down in intermediate trade have been made widely responsible for cyclical variations in the current account. However, the focus on only one of three components of the current account, the trade balance, hides the look on the two other components, net investment income (in the figures labeled as net income) and transfers. It will be shown in this Policy Brief that these two components have also been subject to important changes over the trend and cycle and that these changes vary substantially between six different groups of countries. In particular, both investment income flows and transfers are very likely to become more important as elements of inter-temporal consumption smoothening between emerging markets as the origin of payments to ageing economies as recipients or between emerging markets and advanced countries on the one hand and poor countries as recipients on the other hand (for instance, remittances).

Date: 2012
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