Working Paper: CEPR ID: DP15469
Authors: Philip Saur; Philipp Herkenhoff
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
JEL Codes: F30; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expected inflation (E31) | current account (CA) (F32) |
| expected inflation (E31) | nominal interest income (E43) |
| nominal interest income (E43) | current account (CA) (F32) |
| inflation effect (E31) | valuation effect of net foreign assets (F31) |
| expected inflation (E31) | absolute value of current account (CA) (F32) |
| expected inflation (E31) | cumulative current account (CA) reduction in the United States (F32) |