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April 22, 2005
Governor Ferguson On Current Account Deficits
In a speech delivered yesterday to the University of North Carolina's Economics Club, Federal Reserve Governor Roger Ferguson laid out the various explanations for the U.S. current account deficits, and his view about what they imply. In the speech he identifies five potential explanations:
-- fiscal policy
-- a structural decline in private saving
-- higher productivity growth in the U.S. attracting foreign capital
-- a slump in foreign demand
-- an expanded willingness of global savers to invest internationally (drawn to the U.S. by its exceptionally well-developed financial sector.)
Here is what the Governor concludes:
To the extent that the contributions of these shocks are reasonably well measured by the macroeconomic model simulations, the most important message I draw from them is that no single factor constitutes a dominant explanation of the deterioration in the U.S. current account balance. That said, our model accords the greatest roles to increased productivity growth, which has made the United States a magnet for foreign saving, and to the slump in foreign domestic demand, which has led to an excess of saving in those economies. The narrowing of the risk premium on dollar assets appears to explain a bit less of the widening of the trade deficit, with the loosening of fiscal policy and reduction of private saving making still-smaller contributions. Of course, these results are the product of our model-based analysis, with all of the strengths and weaknesses that model simulations entail; it would be useful to complement these findings with more direct historical and empirical analysis of the U.S. external imbalance.
Governor Ferguson joins Governor Bernanke in warning that putting our fiscal house in order may not eliminate the current account deficits:
The view that the current account deficit stems from economic developments that are varied and yet intertwined has important implications for how the deficit will be corrected. Such a view suggests to me, first, that government policies such as budget-cutting or encouragement of private saving are unlikely, by themselves, to correct the current account deficit, much as they might be desirable for other reasons. Such policies probably do not address all or even most of the root causes of the current account deficit.
However, the fact that I have deemphasized government policy as the source of the adjustment process does not mean that the public sector has no role to play... Appropriate macroeconomic and structural policies in many economies can contribute to the private-sector adjustment process by fostering an environment of innovation, increased productivity and more-rapid growth of domestic demand.
What will bring the current account back into balance?
The primary impetus toward adjustment of the U.S. current account deficit, when it occurs, likely will come from private markets. Here, however, the multiplicity of factors underlying the large U.S. current account deficit raises questions about how that adjustment will come about. Some of the developments that may have supported the expansion of the U.S. current account deficit might reverse themselves--foreign domestic demand could recover, U.S. private saving rates could rise. And some of the factors that boosted the U.S. trade deficit, such as higher productivity growth or financial innovations that support greater spending, may show up more fully in foreign economies. Notably, all of these developments would take time to restrain the deficit, and any one of them, by itself, might have only a small effect.
There is, of course, the possibility of a harder landings...
A final possibility is that, as U.S. deficits widen and foreign claims on the United States mount, actions by investors to re-balance their accumulation of assets could lead to changes in exchange rates, interest rates, and other asset prices that might contribute to a reversal of the deficit.
... but Governor Ferguson is not convinced:
To the extent that the adjustment of the U.S. current account is driven by fundamental changes in the global economy, it is less likely, in my view, to be disruptive or disorderly. Our own experience with external adjustment in the 1980s was comparatively orderly, and so was the experience of many other industrial economies undergoing adjustment in recent decades. Of course, should adjustment prove disruptive to sustainable growth and stable prices, the Federal Reserve will certainly be prepared to act. However, my sense is that the implications of current account adjustment for U.S. economic growth and inflation will most likely be benign.
UPDATE: Calculated Risk reports on today's speech by Governor Don Kohn, wherein he discusses his views on the current account and hints that the housing market is maybe, possibly, could be, not quite right.
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