In search of greater global balance

• Author: Roberto Cardarelli/Alessandro Rebucci
• Position: IMF Research Department
• Pages: 89

Page 89

Some analysts argue that large global imbalances-the U.S. trade deficit and the surpluses of some advanced economies, emerging markets, and oil exporters-can be sustained for a relatively long time because they reflect secular changes in the global economy, such as the integration into world markets of countries with large and underutilized labor forces and the relatively less rapid aging of the U.S. population. According to this view, the narrowing of the imbalances will depend on a rebalancing of the saving and investment behaviors of the United States and the surplus economies, with exchange rate realignment playing a minor role.

Others argue that because of the incomplete global integration of markets for goods and services and the rigidities that impede the reallocation of resources to tradable sectors, a narrowing of global imbalances will require a rebalancing of demand between the United States and surplus economies plus considerable movement in real exchange rates to avoid a prolonged U.S. recession.

The issue: Large external imbalances are considered potentially risky, but how can they be reduced?

The bottom line: Cross-country experiences suggest that a market-led realignment of real exchange rates, in conjunction with a balancing of demand across countries, can smooth the unwinding of external imbalances.

The debate: There's no consensus about how long such imbalances can be sustained or the channels through which adjustment takes place.

History sheds some light

Chapter 3 of the IMF's April 2007 World Economic Outlook (WEO) looks at a broad range of countries over the past 40 years to identify episodes of large external imbalances. It then looks at the length of the episodes and the roles real exchange rates and changes in growth differentials played in the adjustment of the imbalances.

The WEO analysis shows that movements of real exchange rates helped smooth the rebalancing of demand involved in the narrowing of external imbalances. GDP growth declined less in advanced countries undergoing a large and sustained reversal of external deficits when their currency depreciation was relatively large (see chart).

Domestic policies were also important for external adjustment. In particular, increases in saving rates and strong fiscal consolidation in deficit countries helped sustain investment and growth rates. For both advanced and...