Abstract
This paper builds a two-country model with differential productivity and financial frictions to quantitatively account for the recent increase in the U.S. current account deficit. An influential literature says that as U.S. productivity surged, capital was attracted to the United States to take advantage of the high returns to investment. We show, however, that when we include emerging Asia, the gap in productivity growth between the United States and the rest of the world cannot explain the U.S. current account deficits, especially since 2000. This is because on a gross domestic product-weighted basis, the rest of the world actually had higher productivity growth during this period; and standard macroeconomic models would predict an outflow of funds from the United States to the rest of the world, and a consequent narrowing of the U.S. current account deficit. This paper shows that greater financial integration abroad can explain this anomaly. However, we still cannot explain why U.S. per capita output growth has been so low, despite the large inflow of capital.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
See Dekle, Eaton, and Kortum (2006) for the role of China and emerging Asia in explaining U.S. current account deficits; and how much exchange rates need to adjust to equilibrate the U.S. current account deficits.
Other papers using dynamic optimizing frameworks to analyze the U.S. current account include Cavallo and Tille (2006), and Faruqee and others (2005).
Choi, Mark, and Sul (2008) also use an imperfect asset market model to trace the actual time path of the U.S. current account. Like us, they too find that the time path of the U.S. current account cannot be explained by U.S. and “rest of the world” productivity differences. The authors attribute the unexplained portion of the U.S. current account to a declining pure rate of time preference of foreign residents.
The assumption of equal population size is for simplicity. Relaxing the assumption would modify the resource constraints. Our main findings would not change.
We assume a balanced budget for the government. An alternative way to do our exercise would be to allow for budget deficits, and also allow government to trade in bonds along with households.
We could not detect any statistically significant correlation between our calculated “foreign” (European Union and Japan; and EU, Japan and emerging Asia, respectively) and “home” (U.S.) TFPs. Despite this lack of correlation in the productivity shocks between the two regions, as a robustness check of our basic results presented in the paper, we performed impulse response analysis, imposing some spillover of shocks between the regions (contemporaneous correlation of shocks of 0.05). None of the impulse responses were affected.
Following Choi, Mark, and Sul (2008), we also experimented with other detrending procedures, including the HP-filter. We find that using alternative measures of long-term trend growth rate like 1.5 percent or 2.15 percent do not alter our results. Nelson Mark pointed out that the results might be sensitive to HP-filtering. We find that while the pattern of TFP shocks changes with HP-filtering, the effects of the HP-filtered TFP shocks on the U.S. current account and other macroeconomic aggregates are essentially the same as the effects of our constant detrended TFP shocks (results available upon request from the authors).
For the sake of brevity, we do not present the results of assuming a random walk process here.
The data are downloadable from http://www.ssc.wisc.edu/mchinn/kaopen2005.xls.
References
Backus, David K., Patrick J. Kehoe, and Finn E. Kydland, 1992, “International Real Business Cycles,” Journal of Political Economy, Vol. 100, No. 4, pp. 745–775.
Baxter, Marianne, and Mario J. Crucini, 1995, “Business Cycles and the Asset Structure of Foreign Trade,” International Economic Review, Vol. 36, No. 4, pp. 821–854.
Bernanke, Benjamin, Mark Gertler, and Simon Gilchrist, 1995, “The Financial Accelerator and the Flight to Quality,” Review of Economics and Statistics, Vol. 78, No. 1, pp. 1–15.
Caballero, Ricardo, Emmanuel Farhi, and Pierre-Olivier Gourinchas, 2006, “An Equilibrium Model of ‘Global Imbalances’ and Low Interest Rates,” NBER Working Paper 11996 (Cambridge, Massachusetts, National Bureau of Economic Research).
Cavallo, Michele, and Cédric Tille, 2006, “Could Capital Gains Smooth a Current Account Rebalancing?” Federal Reserve Bank of San Francisco Working Paper 2006-03 (January).
Chakraborty, Suparna, and Robert Dekle, 2008, “Can Productivity Shocks Explain the U.S. Current Account?” Review of International Economics, forthcoming.
Chari, V.V., Patrick J. Kehoe, and Ellen R. McGrattan, 2007, “Business Cycle Accounting,” Econometrica, Vol. 75, No. 3, pp. 781–836.
Chinn, Menzie, and Hiro Ito, 2005, “Current Account Balances, Financial Development and Institutions: Assaying the World Savings Glut,” Journal of International Money and Finance, Vol. 17, No. 3, pp. 546–569.
Choi, Horag, Nelson Mark, and Donggyu Sul, 2008, “Endogenous Discounting, the World Saving Glut, and the U.S. Current Account,” Journal of International Economics, Vol. 75, No. 1, pp. 30–53.
Cole, Harold L., and Lee Ohanian, 2004, “New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis,” Journal of Political Economy, Vol. 112, No. 4, pp. 779–816.
Dekle, R., 1998, “Financial Market Implications of the Japanese ‘Big Bang’ Reforms,” Journal of Asian Economics, Vol. 8, No. 2, pp. 237–249.
Dekle, R., and Ken Kletzer, 2003, “The Japanese Banking Crisis and Economic Growth: Theoretical and Empirical Implications of Deposit Guarantees and Weak Financial Regulation,” Journal of Japanese and International Economies, Vol. 17, No. 3, pp. 305–335.
Dekle, Robert, and Guillaume Vandenbroucke, 2006, “A Quantitative Analysis of China's Structural Transformation,” IEPR Working Paper 06.51 (University of Southern California, Institute of Economic Policy Research).
Dekle, Robert, Jonathan Eaton, and Samuel Kortum, 2006, “Unbalanced Trade,” American Economic Review (P and P), Vol. 97, No. 2, pp. 351–355.
Dooley, M., D. Folkerts-Landau, and P. Garber, 2004, “The Revived Bretton Woods System: The Effect of Periphery Information and Reserve Management on Interest Rates and Exchange Rates in Center Countries,” NBER Working Paper No. 10332 (Cambridge, Massachusetts, National Bureau of Economic Research).
Engle, C., and J. Rogers, 2006, “The U.S. Current Account Deficit and the Expected Share of World Output,” Journal of Monetary Economics, Vol. 53, No. 5, pp. 1063–1193.
Faruqee, Hamid, Douglas Laxton, Dirk Muir, and Paolo Pesenti, 2005, “Smooth Landing or Crash? Model-Based Scenarios of Global Current Account Rebalancing,” paper presented at the National Bureau of Economic Research conference on “G-7 Current Account Imbalances: Sustainability and Adjustment,” Newport, Rhode Island, June 1–2.
Greenwood, Jeremy, Zvi Hercowitz, and Gregory W. Huffman, 1988, “Investment, Capacity Utilization and the Real Business Cycle,” American Economic Review, Vol. 78, No. 3, pp. 402–417.
Hunt, Benjamin, and Alessandro Rebucci, 2005, “The U.S. Dollar and the Trade Deficit: What Accounts for the Late 1990s?” International Finance, Vol. 8, No. 3, pp. 299–434.
International Monetary Fund (IMF), 2005, World Economic Outlook, World Economic and Financial Surveys (Washington, April).
Kehoe, Patrick J., and Fabrizio Perri, 2002, “International Business Cycles with Endogenous Incomplete Markets,” Econometrica, Vol. 70, No. 3, pp. 907–928.
Mendoza, Enrique G., 2006, “Sudden Stops’ in an Equilibrium Business Cycle Model with Credit Constraints: A Fisherian Deflation of Tobin's q,” American Economic Review, forthcoming.
Mendoza, Enrique G., Vincenzo Quadrini, and José-Víctor Ríos-Rull, 2007, “Financial Integration, Financial Deepness and Global Imbalances,” CEPR Discussion Paper 6149 (London, Centre for Economic Policy Research).
Additional information
*Suparna Chakraborty is an assistant professor at the Department of Economics and Finance, Baruch College, CUNY. Robert Dekle is a professor at the Department of Economics, University of Southern California. The authors thank the participants in the 2007 Econometric Society Summer Meetings, the Conference on Current Account Sustainability in Major Advanced Countries at the University of Wisconsin, and especially, Nelson Mark, the discussant for helpful comments.
DATA APPENDIX
DATA APPENDIX
The world in our model is made up of two regions: the United States (referred to as “home”) and the EU-15 and Japan; or the EU-15, Japan and emerging Asia referred to as “foreign.” The emerging Asian region comprises of China, Hong Kong, Indonesia, Malaysia, Philippines, Singapore, South Korea, Taiwan POC, and Thailand.
For our calculations, we need data on national income, employment, hours worked, population, capital stock, and the current accounts. The national income accounts data along with the data on population, employment, and hours worked is calculated from the “Total Economy Database” and the “Industry Growth Accounting Database” that is maintained by the University of Groningen at the Growth and Development Center. The data on the capital stock are not available from the above data set; and we collect it from the Kiel Institute database on capital stocks in the OECD countries. The data for China are from Dekle and Vandenbroucke (2006) and for Korea, capital data for some of the latter years are available from Korea Statistical Yearbooks. We use annualized data for the period 1980 to 2003. Given below is a description of the variables used and how they are constructed from our annualized data.
y it : The per capita output in the United States is calculated as aggregate GDP divided by the population. For the home country per capita output, we consider the weighted aggregate output of the EU-15 and Japan; and the EU-15, Japan and emerging Asia, where the weights are calculated as the share of a country's GDP in the aggregate GDP of the rest of the world (ROW). The population of the home country is similarly calculated as the weighted average of the population of countries constituting our ROW, where the weights are calculated as the population of the constituent country divided by the aggregate population of the ROW. The output data are expressed in our data set in millions of 1990 U.S. dollars.
kit−1/y it : The capital output ratio for the home country is calculated as the share of the weighted capital stock to weighted output, where the weights are measured as before as the share of the variable of the constituent country to the aggregate of the ROW.
l it : Labor is calculated as:
where
E it /N it : Weighted employment to weighted population ratio for home and aggregate employment to aggregate population ratio for the United States.
H it /(50 × 100): Weighted average of annual hours worked to total hours, where total hours is assumed to be 50 hours per week and there are 100 work-weeks. For the United States, instead of weighted hours, we just take the annualized hours worked.
g it : Per capita government expenditure. For our analysis, we need the time series of government expenditure from the United States that we collect from the U.S. Bureau of Economic Analysis. We arrive at the per capita figures by dividing aggregate government expenditures by the population.
current account share: Along with output, we try to match the current account share in output in the United States; where the data come from Bureau of Economic Analysis. The current account balance is collected from the Bureau of Economic Analysis that is in millions of dollars. To get the share of the current account balance in output, we divide the current account balance by GDP. The current account balance data of the United States with individual countries is limited; in particular data for emerging Asia including China are not available before 1999.
weights: To get the weights of the countries that comprise our rest of the world group, we take the GDP figures of individual countries from the Groningen data center which is expressed in millions of 1990 U.S. dollars (converted at Geary Khamis PPPs). The Geary-Khamis conversion method is popular in current international comparative studies as it has some desirable properties. The weights are then constructed by dividing the total GDP of each constituent country by the aggregate GDP of the group where the group comprises of EU-15 and Japan; and the EU-15, Japan along with emerging Asia.
index of financial openness: The index of financial openness was created by Chinn and Ito (2005)Footnote 9 as a proxy for international financial market liberalization. They compiled an index of the degree of capital account openness for 163 countries from 1970 to 2004. The index is calculated on the bases of dummy variables that codify the restrictions on cross-border financial transactions reported in the Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) from the IMF. The dummy variables reflect the four major categories on the restrictions on external accounts: presence of multiple exchange rates; restrictions on current account transactions; restrictions on capital account transactions; and requirements for firms to surrender a fraction of export proceeds. The index is the first standardized principal component of these four variables and it takes higher values for countries that are more open to cross-border capital transactions. For example, the United States that is calculated to be the most open economy in terms of financial openness has an index value of 2.602508 in Chinn and Ito (2005) estimates.
For our measure of financial openness (Figure 6), we take the index from Chinn and Ito (2005) for the group of countries that form our rest of the world, namely, EU-15, Japan, China, and the rest of emerging Asia. We then calculate the weighted average of the index where the weights are given by the share of an individual country's GDP, in the aggregate GDP of the group.