More on the Balance of Payments

5th February
EC563: International Finance
Recap on key relationships
Net saving by the private sector can be
broken down further:
Household sector; financial sector; non-
financial corporates
S I = CA
CA = (Sp I) + (T G)
Flows and stocks
Sectoral net savings flows have a stock counterpart
Take the household sector: net saving is reflected in the
acquisition of financial assets and liabilities
In the case of positive/negative net saving the rate of
acquisition of financial assets exceeds/falls short of the
rate of acquisition of financial liabilities
The difference between the stock of household financial
assets and liabilities is net household financial wealth
NB: net household financial wealth is affected not only
by flows but also by valuation changes
For a detailed account of the evolution of household balance sheets and
financial flows before and during the financial crisis, see Cussen et al (2012):
The Impact of the Financial Turmoil on Households, Central Bank QB, April
The net international
investment position (NIIP)
A measure of the countrys net international financial
wealth
Recall that current account balance = net acquisition of
foreign assets by residents less net acquisition of
domestic assets by non-residents
Movements in the NIIP determined not only by current
account balances but also by valuation changes
(including exchange rate changes)
The NIIP and the national solvency constraint:
sustainability of current account imbalances (see
equation on p10 of Obstfeld)
The intertemporal dimension of current account
imbalances
Good vs bad imbalances*
Due to ageing populations, countries will be
net savers now in anticipation of becoming
net dissavers later
Attractive investment opportunities will
attract financial flows from abroad and permit
current account deficits
Deeper and more liquid financial markets may
attract investors, leading to currency
appreciation and current account deficit
* See Blanchard & Milesi-Ferretti (2009) for extended discussion
Good vs bad imbalances
Why might high saving be bad (i.e. a sign of
distortion)?: lack of social insurance; poor
corporate governance.
Why might low private saving be bad?: could
be driven by asset boom or overly optimistic
expectations
Other examples: sub-optimal investment due to
poorly defined property rights; excessive public
deficits because of political factors
Systemic distortions: excessive reserve
accumulation because of self-insurance motive
So, were pre-crisis imbalances
good or bad?
US: depends on period being examined
(compare 1996-2000 with 2005-2008)
China: a number of very different
interpretations are feasible
Euro zone: seemingly unproblematic at
the aggregate level but not so at a
national level*
* See Giavazzi & Spaventa (2010) and Lane & Pels (2012)
How much does the current
account matter?
Alternative formulation: how much of the recent
crisis is explained by current account
imbalances?
Quite alot: Bernanke (2005)
Not much: Borio & Disyatat (2011)
Some, but gross flows matter more:
Blanchard & M-Ferretti (2009); Obstfeld (2012)
Imbalances symptomatic not causal:
Obstfeld & Rogoff (2009)
Empirical research
Evolution of imbalances during pre-crisis period: Wolf
(2009); Obstfeld & Rogoff (2009)
Look behind imbalances at evolution of sectoral assets
and liabilities in US: Shularick & Wachtel (2012)
Look beyond pre-crisis period to much longer historical
series: Jorda, Schularick and Taylor (2011)
Look behind (net) imbalances at gross financial flows:
Borio & Disyatat (2012); Obstfeld (2012)
Analysis of imbalances within Europe: Giavazzi &
Spaventa (2010); Lane & Pels (2012)
Back to the BOP identity
Current account = Change in resident holdings of foreign assets
- change in resident liabilities to non-residents

= Net capital outflow

= Saving - investment
Note: 1. Gross flows bear little relationship to net flows
2. Gross flows capture only a fraction of international transactions
because the gross flows are themselves net
3. Current account is silent on the financing of domestic investment
4. Pattern of global financial flows cannot be inferred from current
account pattern (that country A is running a deficit with country B
does not imply that B is financing As deficit)
5. Misleading to pair the current account with specific gross flows
(eg movements in external reserves)
Empirical evidence on global
financial flows (and stocks)
Growth of global gross capital flows has dwarfed current account
positions and is mostly attributable to flows amongst advanced
countries
Pre-crisis, the increase in gross financial claims on the US was
three times greater than the increase in net claims.*
Bulk of gross flows into the US were from private sector, not from
official sector.
The most important geographic source of inflows was Europe, not
emerging markets.
Global current account imbalances narrowed marginally in 2008,
but gross capital flows collapsed.
Pre-crisis holdings of privately-issued US mortgage-backed
securities were concentrated in advanced countries (even if total
holdings of US debt securities were very high in China and Japan)
* In other words, even without trade deficits, the US would have attracted
large financial inflows.
The current account and
financial flows
Current account data are too partial (because of netting
in the statistics) to give useful information on the
associated financial flows. The netting embedded in
current account data can be misleading because the
assets acquired by some domestic residents are not
necessarily available to meet the liabilities of other
domestic residents, and because the composition of
claims on the rest of the world, and hence their risk
characteristics may be quite different from the comp-
osition of claims on the domestic economy acquired
by non-residents.
Quoted in Obstfeld (2012)
Example of crisis-relevant flows
obscured by current account
European banks invested in US ABS
Funded positions with dollars borrowed from US money
market funds
These flows netted out at zero in both US and
European BOP financial accounts (why?)
However, they played a key role in US credit growth
(esp housing finance)
The flows originated in both deficit (eg UK) and surplus
(eg Germany) countries
Involved dangerous liquidity mismatches which were
exposed when the crisis broke: European banks
experienced great difficulty in rolling over their dollar
borrowing
References
Ben Bernanke (2005): The Global Saving Glut and the US Current Account
Deficit, Homer Jones Lecture, St Louis
Blanchard and Milesi-Ferretti (2009): Global Imbalances In Midstream?
IMF Staff Discussion Paper
Blanchard and Milesi-Feretti (2011): (Why) Should Current Account
Imbalances be Reduced? IMF Staff Discussion Paper
Borio & Disyatat (2011): Global Imbalances and the Financial Crisis Link
or No Link?, BIS WP No. 3146
Giavazzi and Spaventa (2010): Why the current account matters in a
monetary union lessons from the financial crisis in the euro area
Lane and Pels (2012): Current Account Imbalances in Europe
Obstfeld and Rogoff (2009): Global Imbalances and the Financial Crisis
Products of Common Causes
Obstfeld (2012): Does the Current Account Still Matter?
Jorda, Schularick and Taylor (2011): Financial Crises, Credit Booms and
External Imbalances
Schularick and Wachtel (2012): The Making of Americas Imbalances
Wolf, Martin (2009): Fixing Global Finance, Ch 3