Three Current Account Balances: A Semi-structuralist Interpretation

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Three Current Account Balances A
Semi-structuralist Interpretation

• Menzie D. Chinn
• Jaewoo 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.

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Unprecedented CA deficit
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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

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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).

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• 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

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Whats 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.

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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 CAER
  depreciation with CA improvement ER appreciation
  with CA deterioration.
• The correction of CA deficit due to temporary
  shocks will be accompanied by ER depreciation.

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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.

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The BQ decomposition

• Bi-variate VAR, estimated for the current account
  and the first-differenced real exchange rate.
  Temporary shockno permanent effect on ER

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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

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U.S. Impulse Response
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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?

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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 --gt
  impact depreciation, followed by gradual
  appreciation.

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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
  REERno subsequent reverse movement in REER to
  follow.

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U.S. Current Account
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U.S. Exchange Rate
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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

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Natural not to expect zero balance
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Euro Area
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Japan
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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

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Conclusion

• Via a bivariate decomposition, substantial CA
  adjustment for the U.S., accompanied by ER
  depreciation
• An important qualificationdifficulty to model
  2002-04 an uncharted territory or slow return to
  normalcy?
• Portfolio preference, very broadly construed?
• Counterparts?