Dimitri B. Papadimitriou GLOBAL IMBALANCES AFTER THE ECONOMIC CRISIS Levy Economics Institute International Development Economics Associates (IDEAs) Conference Reforming the Financial System: Proposals, Constraints and New Directions January 25-27, 2010, Muttukadu, Chennai, India

Global imbalances and the crisis Origins of the U.S. external deficit The role of China and oil exporters Plausible future scenarios Measures to address global imbalances Outline

The savings glut hypothesis I will argue that over the past decade a combination of diverse forces has created a significant increase in the global supply of saving - a global saving glut - which helps to explain both the increase in the U.S. current account deficit and the relatively low level of long-term real interest rates in the world today. (…) the developing and emerging-market countries that brought their current accounts into surplus did so to reduce their foreign debts, stabilize their currencies, and reduce the risk of financial crisis (..) Because investment by businesses in equipment and structures has been relatively low in recent years (…) much of the recent capital inflow into the developed world has shown up in higher rates of home construction and in higher home prices. Higher home prices in turn have encouraged households to increase their consumption Bernanke (2005)

Chinese External Sector

Chinese International Reserves

Current Account Behavior for Oil Exporters

Key Global Current Account Balances

U.S. Net Foreign Assets and Current Account Balance

Foreigners Role in Financing U.S. Government Deficit

Foreign Holdings of U.S. Treasury Securities JapanChinaGermanyOil exporters U.K.Financial centers Dec %5.9%4.8%4.7%4.9%8.2% Dec %18.9%2.2%5.2%4.4%7.9% Aug %23.1%1.6%5.5%6.5%9.9% Source: Dep. of the Treasury Financial centers: Caribbean Banking Centers, Luxembourg, Switzerland

The Conceptual Framework Accounting Identity of Financial Balances Current Account Balance Private Sector Balance += { Internal Financial Balance { External Financial Balance Government Balance In 2008 the identity was roughly like this: 1.1% of GDP -6.0% of GDP = -4.9% of GDP Third quarter 2009 the identity was roughly like this: 7.9% of GDP –10.9% of GDP = -3.0% of GDP

U.S. Main Sector Balances and Real GDP Growth

Private Sector Borrowing: Historical Data and Baseline Assumptions

Congressional Budget Office Projections for the Federal Budget

Main Sector Balances in Baseline Scenario

U.S. Exports by Country of Destination

Main Sector Balances in Scenario 1, Postponed Deficit Reduction

U.S. Dollar Exchange Rate (Broad Index) Actual and Projected

Main Sector and Trade Balances in Scenario 2, U.S. Dollar Devaluation and Some Deficit Reduction

Private Consumption as a Share of GDP Global Rebalancing is Necessary

Policies to correct imbalances Revaluation of the currencies of surplus countries will be effective in reducing both global and U.S. domestic imbalances Such revaluation will require concerted actions of Central banks, particularly in East Asia Energy policies can reduce the impact of oil price changes on the U.S. trade balance, and the U.S. oil trade deficit If these fail then...

Unpopular Policies may become necessary Under WTO rules (Article 12), external imbalances can be addressed through protectionist-type measures - non-selective import tariffs - import certificates (Buffet proposal) - import certificates (Levy Institute version) The more effective resolution can probably be achieved only via an international agreement that would change the international pattern of aggregate demand, combined with a change in relative prices. Together, these measures would ensure that trade is generally balanced at full employment.

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