Examining Global Imbalances

• Author: Philip R. Lane and Gian Maria Milesi-Ferretti
• Position: Professor of International Macroeconomics and Director of the Institute for International Integration Studies at Trinity College Dublin/Division Chief in the IMF's Research Department

What new data tell us about the external wealth of nations

External imbalances and financial globalization have been at the top of the international policy agenda for the past few years. Indeed, such influential observers as former U.S. Federal Reserve Chairman Alan Greenspan and his successor Ben Bernanke have argued that the rapid integration of the international financial system during the past decade has played an important role in enabling these imbalances to persist and be easily financed. In addition, emerging market economies, traditionally recipients of foreign capital, have become a major source of net foreign capital outflows and, most notably, have been collectively important in financing the large and growing U.S. current account deficit.

So what is there to worry about if financial globalization means that the current configuration of imbalances represents a new but sustainable regime for the world economy? Is the system unstable, or are analysts unduly concerned about global imbalances? To answer these questions requires some spade work. We need to decide how to measure international financial integration, track down which countries are net creditors and which are net debtors, and assess the magnitudes of the accumulated external holdings.

As it turns out, unearthing this information is not that straightforward. For example, despite notable progress in recent years, there are very significant gaps in the availability of data on holdings of external assets and liabilities (the so-called International Investment Position in a country's balance of payments), all the more so if one looks beyond the past few years. This means that, for a large set of countries, we know neither their net external wealth nor the size and composition of their external portfolios-hindering a truly global analysis.

We have sought to remedy this problem by constructing a data set comprising estimates of external assets and liabilities for more than 140 countries for 1970-2004. Although measurement error is likely to be substantial for a number of countries for which there is limited data availability on cross-country capital flows and holdings, this extensive coverage provides a useful global perspective on the cross-country distribution of external holdings and its evolution, and enables analysis of the sustainability of global imbalances from a policy perspective.

Insights into vulnerabilities

Why is information on net external positions and the magnitude and composition of external portfolios important? Clearly, the assessment of external sustainability requires knowledge of a country's financial exposure to the rest of the world, while information on the size and composition of international portfolios is key to understanding the interdependencies among countries, as well as their respective financial vulnerabilities.

For example, an emerging market country facing a sudden slowdown in capital inflows will be more vulnerable to a crisis if it has large debt liabilities denominated in foreign currency-because domestic currency servicing costs rise with a depreciation-than if it has relied more heavily on foreign direct investment (FDI), when returns are linked to the performance of the domestic economy.

Similarly, the internationalization of portfolios means that shocks in one country are...