Working Paper: NBER ID: w11823
Authors: Caroline Freund; Frank Warnock
Abstract: There are a number of worrisome features of the U.S. current account deficit. In particular, its size and persistence, the extent to which it is financing consumption as opposed to investment, and the reliance on debt inflows raise concerns about the likelihood of a sharp adjustment. We examine episodes of current account adjustment in industrial countries to assess the validity of these concerns. Our main findings are (i) larger deficits take longer to adjust and are associated with significantly slower income growth (relative to trend) during the current account recovery than smaller deficits, (ii) consumption-driven current account deficits involve significantly larger depreciations than deficits financing investment, and (iii) there is little evidence that deficits in economies that run persistent deficits, have large net foreign debt positions, experience greater short-term capital flows, or are less open are accommodated by more extensive exchange rate adjustment or slower growth. Our findings are consistent with earlier work showing that, in general, current account adjustment tends to be associated with slow income growth and a real depreciation. Overall, our results support claims that the size of the current account deficit and the extent to which it is financing consumption matter for adjustment.
Keywords: No keywords provided
JEL Codes: F3; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Larger current account deficits (F32) | Slower income growth during recovery (F62) |
| One percentage point increase in the current account deficit at its trough (F32) | 0.15 percentage point slowdown in annual growth during the first three years of recovery (F62) |
| Consumption-driven current account deficits (F32) | Greater depreciations than investment-driven deficits (H69) |
| One percentage point shift from investment to consumption (E20) | Additional 0.7 percentage points in average annual depreciation during adjustment (G31) |
| Persistent deficits (H62) | Larger net foreign debt positions (F34) |
| Persistent deficits (H62) | Greater short-term capital flows (F32) |
| Persistent deficits (H62) | More extensive exchange rate adjustments (F31) |
| Persistent deficits (H62) | Slower growth (O49) |