Managing Openness
The Disequilibrium Approach The view that current global imbalances are unsustainable starts from the intertemporal budget constraint dictating that a country’s net liability position against the rest of the world at any given time cannot exceed the present value of its future current account surpluses.3 This requirement makes it entirely possible for a country to run current account deficits for a long time, as long as it is capable of running sufficiently large surpluses in the future. Such could be the case of developing countries that borrow from developed countries to invest and accumulate capital and repay their debts once they reach a higher stage of development (Kraay et al. 2005). Alternatively, a developed country could also run current account deficits if in the future it is expected to grow faster than the rest of the world. In effect, the country finances its consumption by borrowing against its future income. In this vein, Engel and Rogers (2006) argue that the U.S. current account deficit might be an outcome of such intertemporally optimizing behavior. Many observers are concerned, however, that the large U.S. external deficits are the result of an unsustainable increase in public or private expenditure, prompted respectively by fiscal expansions and financial innovations. Whether the deficits reflect intertemporally optimizing behavior or excessive spending, the net foreign asset position of the United States has clearly undergone a steep decline. From a creditor position amounting to 10 percent of its GDP at the beginning of the 1980s, the United States had shifted into a debtor position approaching 25 percent of GDP in 2009. In absolute terms, this debtor position is the biggest in the world. Thus, according to the disequilibrium approach, this trend is unsustainable, and the country needs to change the sign of its trade balance at some point. Such a shift, in turn, would entail a depreciation of the dollar to increase U.S. net exports. According to this view, the adjustment process might not be very different from the one that led to elimination of the U.S. external deficits of the 1980s. Figure 3.4 compares
Figure 3.4. U.S. Multilateral Real Exchange Rate Index, 1980–2009 quarter 1, 2002 = 100
index
global imbalances. What we shall label for want of a better term as the disequilibrium approach considers global imbalances an unsustainable phenomenon, requiring adjustment of the U.S. current account and a major depreciation of the dollar. This correction could come in the form of a sudden stoppage of capital flows into the United States and collapse of the exchange rate (Roubini 2009, for example). The second view, or equilibrium approach, asserts that global imbalances represent a situation that, absent changes in its deep determinants, can be self-sustaining. We next review the main lines of both approaches.
150 140 130 120 110 100 90 80 70 60 50
19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08
30
year
Source: International Financial Statistics (database), IMF, Washington, DC. http://www.imfstatistics.org.
the trends in the real effective exchange rate of the dollar during that episode (1981–92) with those observed in the past decade (1998–2009). From its peak at the beginning of 1985, the dollar had depreciated over 40 percent by the end of 1991. The virtual elimination of the current account deficit accompanied the depreciation. In contrast, over the past decade the dollar has followed a pattern of depreciation similar to that observed in the 1980s, although the magnitude of the depreciation since the peak in early 2002 to date has been smaller—around 30 percent. Moreover, external deficits have remained quite large, at least until 2008. Under the disequilibrium view, these deficits suggest that further real depreciation of the dollar is still to come. In fact, numerous studies have subjected the magnitude of the trade balance correction, and of the depreciation necessary to achieve it, to detailed analysis (Obstfeld and Rogoff 2005, 2009, for example). Correcting these external imbalances, according to the disequilibrium view, demands a real adjustment—a reversal of the trade balance. But recent literature has underscored the potentially important role that financial adjustment can also play. Changes in the prices of a country’s foreign assets and liabilities also affect its net foreign asset position. In particular, changes in asset prices—that is, capital gains and losses on foreign assets and liabilities—imply that the current account balance no longer determines the change in net foreign assets. Although financial adjustment has received little attention, it is especially important in the U.S. case owing to return differentials: assets held by U.S. investors abroad yield higher returns than U.S. assets held by foreign investors (Hausmann and Sturzenegger 2004; Gourinchas and Rey 2007a; Forbes 2010). Hausmann and Sturzenegger