The Prospects for Global Imbalances: A View from the IMF
Following up on recent posts (, , , , [5} ) Here's another take on the prospects for resolving global imbalances, from Olivier Blanchard and Gian Milesi Ferretti, "Global Imbalances: In Midstream?" Staff Position Note 09/29 (Dec. 22, 2009):
IV.B. Lower Global Imbalances in the Future
What will happen in the future depends on how long the factors we just listed will be in play [oil price decline, asset price busts, increase in home bias, the hit to durable consumption and investment goods demand].
Below is reproduced the IMF World Economic Outlook's October 2009 forecast for current account balances.
Figure 7 from Blanchard and Milesi Ferretti (2009).
Blanchard and Milesi Ferretti continue:
Clearly, some of them are likely to be transitory. The large output gaps in most countries
will eventually disappear, at a rate determined by the strength of the recovery. And in most
countries, the sharp increase in private saving is likely to unwind as uncertainty is reduced,
and income and asset prices recover; so are, in the opposite direction, the various fiscal
stimuli, which will have to be phased out over time.
But some of the changes are likely to be long lasting, if not permanent:
- Private saving is projected to be generally higher than before the crisis. This is
because, even as output returns to its potential level, asset prices, and thus wealth,
may not return to pre-crisis levels any time soon. The increase in saving is expected
to be larger in the United States, where private saving was unusually low before the
crisis, and where the crisis has probably durably affected saving behavior. To the
extent that U.S. saving is indeed more affected than in other countries, this implies a
reduction in the U.S. current account deficit, and lower global imbalances.
- Investment rates are likely to be significantly lower in a number of countries than
they were before the crisis. To the extent that tighter financial regulation increases
the cost of intermediation, the cost of capital will increase. In the countries that
experienced housing booms pre crisis, housing investment is likely to be low for
some time. To the extent that housing price booms were associated, in many
countries, with large current account deficits (from the U.S. to Spain and Ireland),
this also implies lower deficits in those countries, and lower global imbalances.
- Risk premia on cross border flows to many debtor countries have risen, implying a
higher cost of capital. While these premia are lower now than at the peak of the
crisis, they are likely to remain higher than pre-crisis levels, and lead to a more
modest recourse to external finance. This is also likely to limit the scope for running
large current account deficits, and thus, again reduce global imbalances.
- A factor that has not played out much during the crisis but is likely to be important in
the near future is the reserve behavior of emerging market countries. There are two
reasons for this. We are seeing the first now: the worry about large capital inflows is
leading emerging economies, especially in Asia, to limit exchange rate appreciation
and accumulate further reserves. And more generally, the crisis can be read by many
countries as suggesting that more rather than less reserves are desirable.
So what do these factors imply for the unwinding of global imbalances? If we go back to
past policy advice and the main conclusions of the multilateral consultations, one important
adjustment—the increase in U.S. private saving—is under way. However, other parts of the
global external adjustment process are not in place yet: In response to the crisis, US fiscal
deficits have increased significantly, and will need to decline substantially in the future;
current account adjustment in China, while significant in 2009, may turn out to be largely
temporary, particularly if the renminbi is not allowed to appreciate; and a number of other
emerging market countries are still running surpluses and accumulating foreign reserves.
So how will global imbalances evolve? It is useful to go through a number of scenarios.
The authors outline three scenarios: (1) "ideal", with smooth upward adjustment in US public saving and downward adjustment in China and other East Asian countries; (2) partial adjustment in China and East Asia toward domestic demand and smaller budget deficits in US; (3) partial adjustment in China and East Asia toward domestic demand, but phase out US budget deficits. Figure 7, the WEO forecast, does not match either of these scenarios, but does incorporate elements of Scenario 3. Premier Wen Jiabiao's recent remarks  suggest that Scenario 1 is not terribly likely, but in my view, it's more important to see what occurs rather than what is said, when it comes to Chinese policy.
Other people discussing rebalancing include my friends Eswar Prasad and Frank Warnock. For a "don't worry, be happy" interpretation of large current account imbalances, see Zachary Karabell.
On a related note, see Helmut Reisen's take on whether a large RMB revaluation is necessary. Dani Rodrik argues in favor of subsidizing tradables, rather than currency undervaluation, as a means of reorienting the Chinese economy.