^*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.

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.