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Global Imbalances: Build-Up, Unwinding and Financial Aspects Bulletin de la Banque de France 220/6 - NOVEMBER-DECEMBER 2018 Economy and international financing Global imbalances: build-up, unwinding and financial aspects The 2007-09 financial crisis led to major corrections in global current accounts. However, “global imbalances” persist, raising concerns among economic policymakers. This article focuses on two key aspects of these imbalances. The first part describes how they have evolved over the recent period and how their correction has proved costly, given the required major adjustments in real exchange rates. The second part of the article provides detailed statistics on the size and composition of net and gross international investment positions. Due to the large size of gross positions, the income account has become more important for current account dynamics, contributing to the persistence of global imbalances. Antoine Berthou JEL codes Microeconomic and Structural Analysis Directorate F14, F32 Matthieu Bussière Monetary and Financial Analysis Directorate Laurent Ferrara, Sophie Haincourt, Francesco Pappadà and Julia Schmidt Economic Affairs and International Cooperation Directorate This article has benefited from excellent research assistance by Muriel Métais. Global current account imbalances 449 billion dollars (% of world GDP) size of the US current account deficit in 2017 United States Euro area Brazil Japan China Oil exporters United Kingdom India Rest of the world % of GDP Forecasts 3.5 2.5 euro area current account surplus in 2017 2.0 1.5 1.0 3x-4x 0.5 increase in the gross international investment positions 0.0 of the main advanced economies since 1995 -0.5 -1.0 -1.5 -2.0 -2.5 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: IMF (World Economic Outlook, October 2018). Bulletin de la Banque de France Economy and international financing 2 220/6 - NOVEMBER-DECEMBER 2018 ince the late 1990s, the world economy has been that large imbalances are often a leading indicator characterised by a very substantial growth of of subsequent crises and sudden stops (Bussière and S global current account imbalances, in line with Fratzscher, 2006). As Lane and Milesi-Ferretti (2017) increasing globalisation. Despite a rebalancing process show, current account balances prior to the great that started with the Great Recession in 2007-09, these financial crisis exceeded levels consistent with underlying global imbalances have remained large and persistent, economic fundamentals and thus implied large and in spite of short-term adjustments mainly related to costly adjustments thereafter. These vulnerabilities are commodity prices (see Chart 1). not confined to emerging market economies: large and persistent current account deficits may also precede Current account developments have been particularly banking crises in advanced economies such as European striking in the euro area (see Chart 2). While countries peripheral countries (Gourinchas and Obstfeld, 2012). such as Spain or Italy have rebalanced their current accounts, imbalances still persist, mostly due to the large The recent economic history of the euro area provides an surpluses of Germany and the Netherlands. example of how excessive current account imbalances may be reversed – in an asymmetric way – due to a Should we care about these imbalances? After all, there sudden stop in external funding of domestic agents. It is no reason why all countries in the world should be turns out that the cost of the adjustment, which was mainly balanced at all times, as these imbalances simply reflect driven by a compression of internal demand in deficit a gap between the savings and investment of economic economies, was substantial in terms of employment and agents operating within national territory. The financing economic growth, not only in the deficit countries but capacities and needs of these agents give rise to capital also at the global level. inflows and outflows, which help smoothing consumption and investment over time. In this paper, we first focus on the real costs of global imbalances and highlight the asymmetric role of exchange However, excessive external imbalances are a source rate movements in the build-up and unwinding of global of concern because the funding of deficit countries by imbalances. We then explore the financial side of global surplus economies may be subject to “sudden stops” imbalances as we look at the composition of external (Milesi-Ferretti and Razin, 2000). Experience suggests funding (flows of new external debt and stocks). C1 Global current account imbalances C2 Euro area current account imbalances (% of world GDP) (% of euro area GDP) United States Euro area Brazil Euro area Greece Netherlands Japan China Oil exporters France Ireland Portugal United Kingdom India Rest of the world Germany Italy Spain Forecasts Forecasts 2.5 4.0 2.0 3.0 1.5 1.0 2.0 0.5 1.0 0.0 -0.5 0.0 -1.0 -1.0 -1.5 -2.0 -2.0 -2.5 -3.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 Source: IMF (World Economic Outlook, October 2018). Source: IMF (World Economic Outlook, October 2018). Global imbalances: build-up, unwinding and financial aspects Bulletin de la Banque de France Economy and international financing 3 220/6 - NOVEMBER-DECEMBER 2018 1 The economic costs of external rebalancing: Chart 3 shows how current account variations and the role of the exchange rate real exchange rate variations were related in the period 2002-2006 (left panel) and 2006-2010.1 On the The debate on the macroeconomic costs of global whole, there appears to be a negative relationship rebalancing has attracted renewed interest over the between real exchange rates and the current account past decade. Obstfeld and Rogoff (2001, 2005 balance: a real exchange rate depreciation indeed leads and 2007) pointed out in a series of papers that the to the rebalancing of the current account. Nevertheless, basic mechanism of the adjustment results is a transfer of the elasticity is weak, which implies that large variations real resources from debtor countries to surplus countries of the real exchange rate are required to obtain a regardless of the drivers of global rebalancing. In the substantial adjustment of the current account. debtor country, this transfer leads to (a) a decrease in domestic spending relative to production and (b) a real Interestingly, there is also an asymmetry in Chart 3 depreciation associated with the fall in relative prices. between the build-up and rebalancing periods, as current account variations were more strongly related to the real The debate on these two channels of external rebalancing exchange rate movements in the four years following the dates back to the 1920s and the controversy between peak (rebalancing period) compared with the four years Keynes and Ohlin about Germany’s international before the peak of global imbalances (build-up period). obligations after World War I. Keynes pointed out that the macroeconomic costs of any given amount of war While exchange rate misalignments and competitiveness reparations – the “primary burden” of a transfer – were gaps are not necessarily the main driver of rising magnified by the adverse effects of deteriorating terms imbalances, they represent a cost paid by deficit of trade and real exchange rates – the “secondary countries during the rebalancing period. For example, burden” of a transfer. Ohlin criticised Keynes’ emphasis large current account adjustments were observed in on relative prices, arguing that the income effects from European deficit economies in the early years of the unilateral transfers were the predominant ones, leading global financial crisis, and this adjustment continued to small terms-of-trade adjustment. during the euro area crisis. In this process, real exchange rate variations have played a significant role. This is This section focuses on the secondary burden of a transfer and in line with Banque de France research showing that looks at how movements in real exchange rates contribute the Marshall-Lerner conditions – i.e. the trade elasticity to the build-up and rebalancing of global imbalances. required for a currency depreciation to have a positive impact on the trade balance – are largely fulfilled. In other Assessing the role of the real exchange rate in current words, exchange rate changes do play a role in reducing account imbalances: build-up versus unwinding episodes global trade imbalances, although the effect varies substantially across countries (Bussière et al., 2016). In order to assess the costs of rebalancing, it is important to understand how variations in the current account What are the factors affecting the magnitude of the are related to variations in the real exchange rate. real exchange rate elasticities? Recent research carried The measurement of this relation is the subject of out at the Banque de France on this topic provides us considerable debate among academics, and is also with two pieces of evidence. First, Berthou and Dhyne of interest to policymakers. Indeed, a weak relation (2018) show that very productive exporters react less to between these two variables would mean that large real exchange rate movements than small and weakly variations in the real exchange rate are required to productive exporters. In each country, this tends to reduce rebalance current accounts. the aggregate response of exports to exchange rate 1 This study focuses on a sample of advanced economies and large emerging economies (Brazil, Russia, India, China and South Africa, or the BRICS). The current
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