Global macroeconomic imbalances are shrinking (and not)

The chart is from a recent IMF working paper . Don’t celebrate too quickly, though.

Here’s a description of what has happened since the crisis:

Among deficit countries, the US deficit shrank by over 1 percent of world GDP during the period 2006-13 (0.7 percent between 2007 and 2013), and current account imbalances in “deficit Europe” shrank by 80 percent (about 0.7 percent of world GDP) between 2007 and 2013.

In contrast, current account deficits in the “rest of the world” increased by some 0.3 percent of world GDP (reflecting primarily the deficits of Australia, Brazil, Canada, France, India, and Mexico).

Among surplus countries, Asian economies (China, Japan, as well as other East Asian economies) experienced the biggest decline relative to 2007 (0.8 percent of world GDP), while the surpluses in oil exporters declined modestly and those of other advanced European countries were broadly unchanged.

But there’s a flows vs stock issue here, and the improvement in the former hasn’t been enough to bring about an improvement in the latter:

Back to the paper:

As the top panel shows, global creditor and debtor positions have not shrunk as a ratio of GDP—in fact, they have widened since 2007.

As of 2012, there were four major “creditors” with roughly similar net foreign assets (in the order of $3 trillion): oil exporters, Japan, China and other East Asian economies, and European surplus countries.

On the other side of the ledger, there were 3 major debtor areas with liabilities of over $4 trillion: the United States, European deficit countries, and the rest of the world. As is the case for current account balances, six countries (Australia, Brazil, Canada, France, India, and Mexico) account for the lion share of the rest of the world’s liabilities. Despite the reduction in flow imbalances, creditor and debtor positions as a share of world GDP increased in absolute terms for all countries and regions depicted in Figure 3.

For the stock positions to start actually declining would require either an accelerated improvement in the pace of adjustment beyond that of recent years or larger swings in real exchange rates (to favour the debtor countries).

From the paper’s conclusion:

Real exchange rates have moved in a stabilizing direction only for countries without exchange rate pegs, and only to a modest extent. External adjustment has involved very costly declines in demand in high deficit countries, with dramatic output declines relative to pre-crisis forecasts. …

We interpret this set of results as providing a new wave of evidence that the narrowing of large external imbalances can inflict considerable macroeconomic pain on deficit countries if it requires a sharp adjustment over a limited time horizon, especially (but not exclusively) for countries that lack monetary autonomy.

The problem is most evident in Europe. The countries in the periphery, which are roughly the same as the “Eur deficit” countries in the charts above, moved nearly back into surplus by the end of last year. But the core countries didn’t much shrink their large surpluses that existed going into the financial crisis.

This combination placed upward pressure on the euro, which was not offset by more-aggressive monetary policy. (Whether the ECB’s inability to further ease is more to blame than its unwillingness, we don’t wish to debate here.) Following the paper, the current account adjustment in the periphery countries thus came disproportionately from a fall in demand, which compressed imports and reduced prices of domestic goods and services.

The adjustment in Europe is better seen in this chart from a separate recent paper from the IMF: