The importance of the current account

The current account is the sum of the balance of trade, factor income and cash transfers. It is one half of the balance of payments, together with the capital account. The current account matters in every country for a host of reasons, but it is especially important for small open economies like ours. Here’s the latest data on Ireland’s current account, here’s that data in chart form.

We see the imbalance within the current account throughout the crisis. Much of this imbalance came through the ‘services’ and ‘income’ channels, as we can see in this figure that simply decomposes the components of the current account over time.

Components of the current account.

There is a new working paper from the ECB by Ca’Zorzi et al which shows that, accounting for a host of other factors, the current account imbalance story is really the only one that matters. Once the current account become decoupled from what the authors call ‘fundamentals’, the wheels come off the bus. This paper should be food for thought for our policy makers.

By Stephen Kinsella

Senior Lecturer in Economics at the University of Limerick.

10 replies on “The importance of the current account”

ECB paper: “Thousands of Models, One Story – Current Account Balances In The Global Economy”


The role of the external sector is highly important in Nicholas Kaldor’s work and in his biographer John E King’s opinion the most.

I am waiting for the day when we say “We are all Kaldorians now”.

Your graph tracks symptoms, not causes. The decrease in income *and* the increase in services is due to unemployment. And unemployment is caused by a lack of demand.

The lack of demand is still the problem and has always been the problem.

Why are so many people in positions of power unwilling to see this? It just beggars belief that we’re still having this discussion.

Any analysis of the Irish current account that ignores the huge distortions caused by profitshifting including significant wholesale trade on the merchandise side and in services the booking for tax purposes of revenues in other countries that become spurious Irish exports, amounting to up to 40% of services exports, should not have any credibility.

There are also distortions in respect of companies like CRH which effectively are Irish only because of the location of their headquarters.

Imbalances were the result of several trends rather than the cause of the crisis.

Cheap Chinese goods and the dollar-renminbi peg helped to lower inflation rates in the West but as with Irish data, Chinese export data cannot be taken at face value.

The value added of an Appe iPhone4 for China is about about $8 a pop but the FOB value in China includes components from several countries and as with other Chinese exports into US supply chains, the deficit with China is exaggerated. Intermediate trade with Japan, Taiwan, Korea etc ends up being booked to China.

US productivity also rises when jobs are ‘shipped’ overseas.

The US current account has grown since the 1980s because of stagnant incomes and falling taxes.

A paper by Robert H. Frank and Adam Seth Levine of Cornell shows that in 1980, the median size of a newly constructed house in the United States was approximately 1,600 square feet. By 2001, however, the corresponding figure had grown to over 2,100 square feet—more than twice the corresponding growth in median family earnings. During the same period, the median household experienced substantial growth in consumer debt.

By 2007, one in five American households had zero or negative net worth.

The authors use the term ‘expenditure cascade’ to describe a process whereby increased expenditure by some people leads others just below them on the income scale to spend more as well, in turn leading others just below the second group to spend more, and so on. Their expenditure cascade hypothesis is that a pervasive pattern of growing income inequality in the United States has led to a decline in savings rates.

In the case of Germany, having a range of products and a reputation for quality, were key factors in the rising demand in the growing markets of the world.

Two-thirds of Germany’s surplus is ex-EU27 and tarde within the EMU is almost in balance.

@stephen k

“We have therefore turned the analysis into a single probability
statement, which accounts for both the likelihood of models being “true” and estimation
uncertainty. Out of thousands/millions of models, one consistent story emerges. The chance
that current accounts were aligned with fundamentals prior to the …nancial crisis appears to
be, according to this approach, minimal.”

Had a quick whizz through this looking for some revelatory insight. Must have missed it as the above seems obvious. Might be being dim, what did I miss?

Given Ireland’s open economy, what is striking is that Irish politicians and economists say little if anything of substance on relevant international trends and challenges, with the exception of the narrow focus on Europe.

There has been a long-term trend of specialisation in many sectors and its limits were vividly illustrated by Alan Greenspan, former Fed chairman, at the US Congress in Oct 2008:

REP. HENRY WAXMAN: The question I have for you is, you had an
ideology, you had a belief that free, competitive — and this is your statement — “I do have an ideology. My judgment is that free, competitive markets are by far the unrivaled way to organize economies. We’ve tried regulation. None meaningfully worked.” That was your quote.

You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others. And now our whole economy is paying its price. Do you feel that your ideology pushed you to make decisions that you wish you had not made?

ALAN GREENSPAN: Well, remember that what an ideology is, is a conceptual framework with the way people deal with reality. Everyone has one. You have to — to exist, you need an ideology. The question is whether it is accurate or not. And what I’m saying to you is, yes, I found a flaw. I don’t know how significant or permanent it is, but I’ve been very distressed by that fact.

REP. HENRY WAXMAN: You found a flaw in the reality…

ALAN GREENSPAN: Flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.

REP. HENRY WAXMAN: In other words, you found that your view of the world, your ideology, was not right, it was not working?

ALAN GREENSPAN: That is — precisely. No, that’s precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well.

Vikram Mansharamani, a lecturer at Yale University cites an example of the highly interconnected and global economy where seemingly unrelated developments can affect each other.

Consider the Miami condo market, which has rebounded quite nicely since 2008 on the back of strong demand from Latin American buyers. But perhaps a slowdown in China, which can take away the “bid” for certain industrial commodities, might adversely affect many of the Latin American extraction-based companies, countries, and economies. How many real estate professionals in Miami are closely watching Chinese economic developments?

Professor Philip Tetlock, author of  ‘Expert Political Judgment: How Good Is It? How Can We Know?’, conducted an almost 20-year study of 284 professional forecasters where he asked them to predict the probability of various occurrences both within and outside of their areas of expertise.

Analysis of the 80,000+ forecasts found that experts are less accurate predictors than non-experts in their area of expertise.

Tetlock’s conclusion: when seeking accuracy of predictions, it is better to turn to those like “Isaiah Berlin’s prototypical fox, those who know many little things, draw from an eclectic array of traditions, and accept ambiguity and contradictions.” Ideological reliance on a single perspective appears detrimental to one’s ability to successfully navigate vague or poorly-defined situations (which are more prevalent today than ever before).

Louis Menand, an author and Harvard academic, wrote in a review of Tetlock’s book in ‘The New Yorker’ in 2005: “The accuracy of an expert’s predictions actually has an inverse relationship to his or her self-confidence, renown, and, beyond a certain point, depth of knowledge.

People who follow current events by reading the papers and newsmagazines regularly can guess what is likely to happen about as accurately as the specialists whom the papers quote.”

@Michael Hennigan,

Unlike your classical hedgehog, the Irish hedgehog – comprising governing politicians, policy-makers and regulators – has learned how to develop and exploit one big thing and instinctively knows another. The first big thing, arising from the gradual opening of the economy kicked off in the mid ’50s by Gerard Sweetman, who gave TK Whitaker and his team the sanction to develop it further, and which was then pushed forward by Sean Lemass from 1959, culminating in EEC membership in 1973, was the development of a massive – in relation to the size of the domestic economy – ‘export enclave’ sustained and fostered by state subventions and low taxation providing a perfect – and gleefully exploited – oportunity for tax avoidance by global players on a gargantuan scale.

The second big thing is that the native power elites, exercising both politcial and economic power, must be fostered, cherished and protected at all costs – even to the extent of putting the solvency of the state in peril.

The first big thing is probably the principal thing the Government has at the moment tto generate the growth in GDP that underpins the programme for fiscal adjustment and debt sustainability. Without it, the programme would probably collapse. But many other advanced economies, quite reasonably, view this big thing as depriving them of fiscal revenue to which they believe they should be entitled and which they badly need.

The second big is the reason that it is not possible to pursue the structural refroms required to boost the domestic economy and to counteract the detrimental impacts of the necessary fiscal adjustments.

The first big thing is declining in value and in its ability to contribute; and its continued existence is inviting increasing external pressure that will result in its contribution being diminished even more. This will place increasing pressure on the second big thing to which the Irish hedgehog is holding fast.

Both big things are under threat, but the hedgehog refuses to accept this, refuses to contemplate what needs to done and, instead, just burrrows deeper and deeper.

From a story in today’s Irish Times:

“IRISH PEOPLE’S finances are continuing to deteriorate with the number who say they have less than €25 to spend each week once all essential bills have been paid increasing sharply over the last three months, according to research published by the Irish League of Credit Unions (ILCU). What’s Left tracker survey of the year found that 1.82 million adults say they have less than €100 a month to spend after bills are paid. This compares with a figure of 1.64 million it recorded in April.”

Which Atrios adds:

“I’m not a Very Smart Economist, but I’m a bit flummoxed as to how people with less than 25 euro a week are supposed to stimulate demand. Maybe they should be fired more.”

What has to happen for people to start to see demand as the problem. People don’t have any money – or any way to get it.

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