^*The authors are economists in the International Finance Division of the Federal Reserve Board. This paper has benefitted from comments by our editor Akito Matsumoto, an anonymous reviewer, Trevor Reeve, and participants at the Current Account Sustainability in Major Economies (II) conference at the University of Wisconsin, especially discussant Jeffrey Frankel. Jim Albertus, Sean Fahle and Dao Nguyan provided excellent research assistance.

Abstract

This paper addresses three questions about prospects for the U.S. current account deficit. First, is it sustainable in the long term? Projections of a detailed model of the U.S. balance of payments suggest that the current account deficit will resume widening and external indebtedness will continue to expand. Second, how long will it take for indebtedness to rise sufficiently to prompt some pullback by global investors? We project that external debt, net investment income, and the share of U.S. claims in foreigners' portfolios will take many years to reach levels that would test global investors' willingness to extend financing. Finally, if and when levels of sustainable debt burden are breached, how readily would asset prices respond and the current account start to narrow? We find little evidence that, as countries' indebtedness rises, the changes in asset prices and exchange rates needed to correct the current account materialize all that rapidly.