Three Current Account Balances: A Semi-structuralist Interpretation Menzie D. Chinn Jaewoo Lee The views expressed in this paper are those of the authors.

Three Current Account Balances: A Semi-structuralist Interpretation

Menzie D. ChinnJaewoo Lee

The views expressed in this paper are those of the authors and should not be attributed to the NBER, the International Monetary Fund,

its Executive Board, or its management.

Unprecedented CA deficit

-.08

-.06

-.04

-.02

.00

.02

70

80

90

100

110

120

130

80 82 84 86 88 90 92 94 96 98 00 02 04

USCAY (BEA, SA) REER

A Hundred Views

• Savings glut / investment drought: Bernanke (2005), Chinn and Ito (2005)

• Fed Sigma vs IMF GEM, on fiscal effect • Event studies: Freund and Warnock

(2005), Galati and Debelle (2005)• Portfolio preference/ Valuation: Blanchard

et. al (2005), Gourinchas and Rey (2005), Lane and Milesi-Ferretti (many), Tille (many), and others

Looking at CA and ER together

• Impose a little structure: decompose shocks into those that have a permanent effect on ER and the rest

• Consistent with NOEM models, including an example in Lee & Chinn (2006)

• Nominal shocks have no long-run effect on REER when NFA is stationary.

• Productivity shocks can have long-run REER effects (e.g. Balassa-Samuelson).

• Motivated by the intertemporal view of CA (intertemporal dimension)

• Not all the way to the present value model of CA--too tight a restriction

• PVM papers that illustrate the importance of prices:

Bergin & Sheffrin (2000)--exchange rates Nason & Rogers (2006)--risk premium

What’s this paper to do with imbalances?

• In the earlier paper, the two types of shocks generate different patterns of correlation between CA and ER.

• The exchange rate effects of temporary shocks are bound to reverse course.

• Implications on the prospects for the ER movement and the sustainability of CA.

As a decomposition exercise

• According to the long-run effect on the real exchange rate, with no a priori sign restriction.

• Shocks with temporary ER effect bring about the usual negative correlation between ER and CA—ER depreciation with CA improvement; ER appreciation with CA deterioration.

• The correction of CA deficit due to “temporary” shocks will be accompanied by ER depreciation.

Relating to other imbalance papers

• Compared to Obstfeld and Rogoff (2004/05), we empirically look for the portion of CA adjustment to be associated with ER depreciation.

• Based on time series data, in contrast to event study or cross-country evidence.

• Econometric, in contrast to DSGE.

The BQ decomposition

• Bi-variate VAR, estimated for the current account and the first-differenced real exchange rate. Temporary shock—no permanent effect on ER

( ) (0)T

t t tP

t t t

ca caB L B

q q

Data for estimation

• Quarterly data, SA, current account to GDP ratio; log difference of the CPI-based REER

• U.S., 1980Q1 (Q4) - 2001Q4, adjusted for the Gulf War transfers of the early 1990s

• Japan, 1980Q1 (Q4) - 2004Q3

• Euro area, 1980Q1 (Q4) - 2004Q4, current account data from EABCN

U.S. Impulse Response

.0012

.0014

.0016

.0018

.0020

.0022

.0024

1 2 3 4 5 6 7 8 9 10

Response of CA to Temporary Shock

.0012

.0014

.0016

.0018

.0020

.0022

.0024

1 2 3 4 5 6 7 8 9 10

Response of CA to Permanent Shock

-.03

-.02

-.01

.00

.01

.02

1 2 3 4 5 6 7 8 9 10

Response of DRE to Temporary Shock

-.03

-.02

-.01

.00

.01

.02

1 2 3 4 5 6 7 8 9 10

Response of DRE to Permanent Shock

.0004

.0008

.0012

.0016

.0020

.0024

2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Response of CA to Temporary Shock

.0004

.0008

.0012

.0016

.0020

.0024

2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Response of CA to Permanent Shock

-.03

-.02

-.01

.00

.01

.02

.03

.04

.05

2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Response RE to Temporary Shock

-.03

-.02

-.01

.00

.01

.02

.03

.04

.05

2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Response of RE to Permanent Shock

Candidate shocks

• Temporary shocks: – monetary shocks– real shocks that entail temporary appreciation and CA

deficit– productivity shock without REER effect?

• Permanent shocks: – preference shocks, e.g. in favor of home exports

(appreciation and CA surplus) – government spending (negative preference shock)– oil price?

Temporary shocks correspond to the typical view of adjustment

• The imbalance (read deficit) of current account that is caused by temporary shocks will have been accompanied by REER appreciation.

• Resolution in a reverse movement, namely improving CA and depreciation.

• Kim and Roubini (2000) : monetary stimulus --> impact depreciation, followed by gradual appreciation.

Different with permanent shocks

• Current account deficit caused by permanent shocks will have been accompanied by REER depreciation.

• Moreover, the resolution of the deficit will not necessarily involve much further movement in REER—no subsequent reverse movement in REER to follow.

U.S. Current Account

-.07

-.06

-.05

-.04

-.03

-.02

-.01

.00

.01

82 84 86 88 90 92 94 96 98 00 02 04

CAUS Non-transitory Deterministic

U.S. Exchange Rate

70

80

90

100

110

120

130

82 84 86 88 90 92 94 96 98 00 02 04

REUS Non-transitory

U.S. External Balance

• CA deficit of 5.7 percent of GDP (in 2004) may decline to 4.1 percent of GDP, accompanied by further ER depreciation

• ER depreciation of 10-20 percent

• CA deficit to decline ultimately to about 3 percent of GDP, not involving ER

• CA deficit and stable external debt-to-GDP ratio fully compatible

Natural not to expect zero balanceFigure 1. Global Distribution of Current Accounts, 1960-2003

(in percent of GDP)

0

-20 -15 -10 -5 0 5 10 15 20

Current Accounts

1960

1970

1990

2003

1980

Euro Area

-.12

-.08

-.04

.00

.04

.08

82 84 86 88 90 92 94 96 98 00 02 04

CAEU Non-transitory Deterministic

Japan

-.01

.00

.01

.02

.03

.04

.05

82 84 86 88 90 92 94 96 98 00 02 04

CAJA Non-transitory Deterministic

Euro and Japan

• Not much evidence of external imbalance, though small surplus driven by temporary shocks

• The adjustment to entail some real appreciation, a bit more for Japan

• Implies other counterparts to the U.S. deficit than the euro area or Japan

Conclusion

• Via a bivariate decomposition, substantial CA adjustment for the U.S., accompanied by ER depreciation

• An important qualification—difficulty to model 2002-04: an uncharted territory or slow return to normalcy?

• Portfolio preference, very broadly construed?

• Counterparts?