Leading into the G20 meetings the US proposed strict limits on current account to GDP ratios. By the end of the meetings the usual vague communique was issued, but President Obama claimed victory went to the US in the currency (current account) wars. Surprising, given that the aim of the proposed policies was China, and for China it will be business as usual. Follows is my piece on this in the Age today…
In the lead up to the G20 summit US Treasury Secretary Geithner proposed that countries aim to keep current account surpluses and deficits within a range of plus or minus 4 percent of GDP. The target of such a policy is China, with the presumption being that the requirement to keep surpluses in the required range would force China to allow its exchange rate to appreciate more quickly against the US dollar. In the end the G20 communique came out with a much more vague statement around multilateral cooperation to promote external sustainability, presumably measured through the size and persistence of current account balances. [DDET Read more]
The original suggestion of specific current account targets had a number of problems. Firstly, it would affect a very large number of countries, rather than just China. During 2008 about half of the countries in the OECD breached this limit, with countries such as Australia, New Zealand and the US among the deficit countries, and Germany, the Netherlands and Norway among the surplus countries. In 2008 Norway’s current account surplus was 19.6 percent of its GDP, compared with China’s surplus of 9.8 percent of GDP.
A more general difficulty surrounding any policy to try to tackle current account balances is that trying to move current account deficits and surpluses is easier said than done. The current account balance reflects the level of spending in a country relative to the level of production. Surplus countries spend too little relative to production, while in deficit countries the opposite is true. So, surplus countries should take action to encourage greater levels of spending, both through encouraging consumption and perhaps loosening fiscal policy if the economy is weak. Deficit countries need to reduce spending or increase productivity and output to reduce the spending gap.
But the problem is that adjusting spending in the desired direction is not easy. In Australia we have had a debate about the extent to which our current account deficits are a problem for many years. In the 1980s policymakers tried to reduce our current account deficits by reducing the government’s budget deficits, and by trying to force households to save more and spend less through the introduction of compulsory superannuation. Despite these policies the current account deficit did not get any smaller. We also had very tight monetary policy during the 1990s recession, which some thought might reduce spending in the economy and lower the deficit. But production fell as well as spending, so the current account deficit did not fall.
Today our current account deficit remains greater than four percent of GDP during most years, but most economists do not see this as a major problem requiring significant adjustments in macroeconomic policy. The current account deficit can be seen as being caused by the relative strength of our economy, with high levels of investment compared to other OECD countries. As that investment bears fruit over time the current account deficit ought to fall. Further increases in compulsory superannuation might be a desirable way to try to reduce the current account deficit, but other government policies ought not to explicitly target the current account.
Is this argument regarding a benign current account deficit or surplus applicable to other countries? Not always. Norway is an example of a country having a very large current account surplus which should be viewed as being desirable. Norway has a lot of oil, but oil production and revenues are expected to run out in the medium term. The Norwegian government is saving a lot now in anticipation of smaller future revenues, and that drag on what spending could be is keeping the current account surplus very high. It would be entirely inappropriate for Norway to be forced to loosen policy to try to achieve a much smaller current account surplus. Germany and Japan also have very large current account surpluses, but in those countries these surpluses reflect a lack of confidence among firms and business people about the future of their economy. It would be desirable for these countries to grow more quickly and have smaller surpluses, but this is easier said than done.
In China the current account surplus is not desirable because it reflects a lack of household spending, and too little spending on imports due to the artificially low exchange rate. But the preference among Chinese policymakers it to slowly increase demand and the exchange rate, rather than making major adjustments in either – a slow and steady approach that has served China’s economy well during three decades of reform.
On the deficit side the United States has a large current account deficit which is a problem. As with Australia, the current account deficit reflects in part the very low level of savings by households, but in the US the current account deficit is made larger not by high levels of private investment, but by excessive budget deficits in the past decade. The problem that the US now faces is that it does not want to reduce budget deficits in the face of the still weak recovery in the US economy. Given that the US is unlikely to take any action to reduce its current account deficits, it is unreasonable for US policymakers to expect other countries to take policy actions aimed at moving their current account balances. [/DDET]