Five essays on the balance of payments

Abstract

The current account of the balance of payments, broadly defined as the change in the net foreign asset position of a given country vis-à-vis the rest of the world1, is one of the most often debated economic variables, both from a policy and from an academic perspective. The policy interest for current account issues stems from the fact that large current account deficits, which imply an accumulation of net foreign liabilities, are perceived to be often associated with sudden “disorderly” adjustments and a high social cost. The balance of payment crises that affected, in particular, emerging markets in Latin America and Asia in the past decades are an example of such dramatic corrections. These sometimes severe adjustments have also triggered a collapse of the domestic financial system and a fall in output, while being also held responsible for contagion to other countries. Similarly, the sometimes significant current account deficits run by the United States or by the transition economies of Central and Eastern Europe have been recurrent sources of concern. Because the current account involves, by definition, other countries, it is not only an issue for the domestic residents but also for foreign residents; the current account can be seen as a key variable in the international transmission of shocks. One of the key mechanisms through which a current account imbalance can be corrected is an adjustment of the real exchange rate. The balance of payments crises that affected, among others, Mexico in 1994 or Thailand in 1997, have been accompanied by a severe depreciation of the nominal exchange rate. For the ten countries that joined the European Union in 2004, concerns for their current account positions relate in particular to their ability to maintain exchange rate stability in the context of the ERMII process. Meanwhile, the emergence of a noticeable current account deficit in the US is often identified as one of the factors behind the depreciation of the dollar against the euro that started in 2002. Understanding what determines the current account therefore also represents an important step towards understanding the determinants of other economic variables such as asset prices 2 It is therefore no surprise that current account matters often come at the forefront of the agenda in international policy meetings, while two of the most important international organizations, the International Monetary Fund and the World Bank, have been largely founded to address balance of payments adjustment issues.3 Specifically, two questions are recurrent in the policy debate: first, what constitutes an appropriate current account position for a given country; and second, how can the current account adjust towards this appropriate position? These two normative questions are intimately related to a third - positive - question, i.e. what are the determinants of the current account?