External Adjustment and the Global Crisis

Readers may be interested in this new research paper that looks at current account adjustment over 2008-2010.

Summary: After widening substantially in the period preceding the global financial crisis, current account imbalances across the world have contracted to a significant extent. This paper analyzes the factors underlying this process of external adjustment. It finds that countries whose pre-crisis current account balances were in excess of what could be explained by economic fundamentals have experienced the largest contractions in their external balance. External adjustment in deficit countries was achieved primarily through demand compression, rather than expenditure switching. Changes in other investment flows were the main channel of financial account adjustment, with official external assistance and ECB liquidity cushioning the exit of private capital flows for some countries.

8 replies on “External Adjustment and the Global Crisis”

Pls tell me the ‘liquidity cushioning’ comes from ELA, and not Target2 generally… ?

@ Philip Lane

I have no embarrassment in saying that the IMF paper you link to is way beyond my level of mathematics or comprehension.

On a more general note I would welcome a more down to earth introduction to the current acount figures as produced by the CSO. I do not fully understand them and have a lot of doubts as to whether they reflect the ‘national position’, in the sense of the current account surplus attributable to the individual residents of the country.

The current account surplus has been referred to a number of times as a portent of good tidings to come. I seem to remember similar talk in the 1980’s. But where is the connection to incomes and jobs?

Much of the CA surplus, which is v welcome, comes from TNC’s Joseph. As such it is only very loosely attributable to (taxable, relatively fixed with bank accounts that can be deposited in domestic banks and/or seized and/or induced to servicing the government, us tax repatriation issues aside) residents of the country.
But, it’s better than a deficit

Many thanks to Philip for posting what is, as Joseph says, a technical paper. This about modelling the various factors the factors involved in recent changes in current account balances in a representative global sample of countries The relevant factors are listed on pages 8-9, and they are interesting to think about .

The paper is not about Ireland as such, but it throws some light on our situation. The global credit crunch exposed the weaknesses of the Irish banks, leading to collapses in asset values and capital flight. The ECB had to step in to prevent the contagion spreading to core EZ banks. This had the effect of damping capital flight, and, I imagine, also avoiding associated disruption of the current a/c..

As Phlip 11 says, the TNC presence is what gives us our current a/c surplus. As I understand it, we have goods trade, service trade, and capital movements within TNCs. The latter factors are very large but in principle unknowable. They are protected by commercial secrecy, although they have a huge impact on our national finances.

Lets face it. Little countries don’t get to call the terms when they are dealing with global business giants. Yes its better than a deficit, and it makes our current account look fantastic, but the whole arrangement is at the mercy of decsions way beyond our shores. Merkel and Sarko discussing a common tax regime. Look out below.

@ Joseph

A current account surplus is seen as benign because when you have a large outstanding stock of public and private debt the only way to delevage is via current account surpluses, given the economic identity:

Private Savings + Public Savings= The Current Account

However, this not entirely true, sectors within the domestic economy could sell off assets to pay down debt, but the only way to affect the net lending position in the domestic economy is via current account surpluses.

Philip Lane is taking the view of the crisis being driven by excessive borrowing in this paper, whereas many people, myself included, would see the crisis as a result of excessive saving in Germany, Japan, and China (the 2nd, 3rd and 4th largest economies in the world), sustained through a combination of currency manipulation (the yuan/dollar peg, the euro) domestic policy issues (poor demographics, lack of a welfare state in China) and deliberate policy action to balance the economy towards export led growth as opposed to domestic consumption. It is an ongiong debate.

Paul and Philip – my understanding of the current account balance is that whatever gets picked up as a merchandise balance for MNC’s all goes back out as services imports or incomes (MNC’s profits) so the net impact of MNC’s is not as big as you think though v. much open to correction

Joseph Ryan
I never get these highly technical papers that go on to conclude something very obvious. I hope I am correct in saying that a CA balance is the balance of trade in goods and services plus or minus repatriated profits/dividends. This balance is always offset by the capital account balance. If that is so and a high deficit country, living beyond it’s means by borrowing from abroad, suddenly finds that it can’t borrow as much as before, then it must be inevitable that demand adjusts to a lower level.

If I am correct here, I can understand how a ca surplus is better than a deficit, but I fail to see how this can be used to lower fiscal deficits. Can somebody explain that? If the surplus is a function of private sector deleveraging (CA surplus and capital Account deficit implies that the private sector is repayig debt), then I suppose in 20years or so, the private sector will have repaid debt and the economy will be smaller but healthier. What I fail to see is how that helps public sector finances. If the economy is getting smaller and healthier but government is acting to keep it big, by spending more than it makes, where is the breaking point? Can government take more of the private sector surplus to repay the debt (higher taxes) or is this really a hope that a re-set occurs, the private sector deleverages enough to be healthy and then it can borrow more?

In this environment where public sector debt is considered every day more unsustainable, I wonder if the private sector shrinkage can be offset by public sector expansion for long enough to work, because if it doesn’t and we get both private and public sector shrinkage, then we see real massive problems.

“We view the process of widening current account imbalances during the period preceding the crisis (particularly during 2004–2008) as reflecting a variety of factors, among which asset price booms and easy access to external finance are particularly crucial. The crisis was associated with a sharp increase in risk aversion, declining asset prices, and significant downward revisions to growth expectations for a variety of countries. ”

I sometimes think that the job of economists is to take facts and to weave a nest with them, then sit atop of the nest crowing that we have built our own reality here! Fine! but what about the rest of us looking from the ground up that nest looks very different from our perspective.

The crisis in my country was also associated with a dearth of standards in politics which led to astoundingly poor financial regulation. throw in the reward schemes within banks that only rewarded those that took the most egregious actions and which were guaranteed to eventually drive those banks and any state that tried to stand over them, into insolvency. Likewise, next reason for Ireland’s demise was looting of the public purse by the “Social Partners” a misnomer if ever there was one since what they were about was totally anti, the very concept of society, which involves a sense commonality and responsibility to the greater good. In Ireland, there was no greater good and still is no greater good, than lining one’s own pocket. It mattered not a whit, whether you were in government in trade unions, in banks or on the developer gravy train feeding greedily off the above malaise. Bankers got the “blanket guarantee”
Auctioneers, estate agents, accountants, barristers and top feeders got NAMA. Public servants got Croke Park and ordinary people eventually got the MOU and will eventually have to live with the consequences of a default……the democratic deficit in the EU is far to great to allow Eurobonds to be floated. Angela Merkel has 23% support in Germany, strangely she has more support in France, but not much more, than Nicolas Sarkosy.

One, could easily, say the reason why the price of a property dropped from 500,000 Euro to 250,000 and beyond was to do with “credit squeeze” or “risk aversion”. Alternatively, you could admit that the price of a one bed apartment in Dolphin’s Barn should never have approached the price of a similar apartment in the heart of Paris. I would like to see Philip Lane taking some time off from these academic papers, which to my mind are a placebo and substitute activity from addressing real issues in our society. Those isuess require, like never before, the plain speak of your counterpart over at UCD . At least, Mr. Kelly, like him or loathe him, speaks plainly without hiding behind the obfuscation of technical analysis. I think it is time to be patriotic rather than academic and I believe there is a duty on all economists in this regard. Let me give one small example, you studied and produced some material with your then colleague Patrick Honohan on the NPRF some 10 years ago and warned what would happen if it was not ring fenced from government raids and the consequences of mono investing or not spreading risk. What is your take on this issue now? It was Patrick Honohan’s signature along with that of the late Mr. Lenihan that signed off on the MOU one consequence of which was to insure that the fund would be used to prop up insolvent banks, there has been a conspicuous silence on these kinds of issues.

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