## Understanding Global Imbalances (ppea2026006) ## Source details **Canonical URL:** [Understanding Global Imbalances (ppea2026006)](https://www.imf.org/-/media/files/publications/pp/2026/english/ppea2026006.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2026/english/ppea2026006.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2026/english/ppea2026006.pdf.json) --- ### EXECUTIVE SUMMARY — Overview and key takeaways - Global imbalances narrowed for more than a decade but have widened recently; the recent widening reverses the steady narrowing since the global financial crisis. - Large, persistent surpluses and deficits can be consistent with fundamentals but raise concern when driven by policy distortions and when they unwind disorderly. - Expansion of industrial policies and rise in trade restrictions have intensified debate on drivers of current account balances despite limited empirical clarity on their net effects. - Key stylized facts: - Imbalances are highly concentrated and persistent among a small set of systemic economies. - Trade balances remain a significant component of current accounts. - Accumulated surpluses and deficits have produced historically large stock imbalances, raising vulnerability to financial shocks. - Valuation effects now play a larger role in changes in external wealth for economies with large gross cross‑border positions. ### Analytical framework and EBA methodology - Conceptual anchor: intertemporal (saving–investment) approach — current account reflects forward‑looking saving and investment decisions. - Framework components: cyclical factors, macro/structural fundamentals, policy drivers, and spillover transmission. - EBA methodology (three components): - (i) cross‑country regression model to benchmark the current account; - (ii) regression models to benchmark the real effective exchange rate (REER); - (iii) the external sustainability (ES) approach for large NIIP cases. - EBA outputs: - Current account norm (퐶퐴푖푖푖푖 consistent with fundamentals and desirable policies). - Current account gap = realized (adjusted for cyclical factors) − norm; positive gap implies more surplus (or less deficit) than warranted. - Policy gap (quantifies contribution of fiscal stance, foreign reserve accumulation, capital controls, public health spending deviations) plus residual. - Role of staff judgment: model outputs combined with staff adjustments/adjustors where analytically grounded. ### Findings on trade policies (uniform tariffs) - Partial equilibrium intuition: unilateral tariffs raise import prices and can suggest improvement in the trade balance, but final CA impact depends on saving and investment responses. - Duration matters: - Temporary tariffs can increase the current account by postponing consumption. - Permanent tariffs are broadly neutral in simple intertemporal models where investment does not respond. - When investment responds: - Higher input costs and lower export demand can depress investment and overturn neutrality. - Tariff-generated terms‑of‑trade gains redistributed to households can reduce saving, muting CA improvements. - Retaliation negates terms‑of‑trade benefits. - Exchange rate interaction: - Neutrality of permanent tariffs requires exchange rate appreciation; if the exchange rate cannot appreciate, permanent tariffs may have a larger positive CA effect. - Model simulation highlights: - Temporary tariffs increase CA. - Permanent unilateral tariff increase of 10 percent expected permanent → broadly neutral CA when revenues transferred to households; modest CA increase when revenues used to pay down government debt (fiscal channel). - Under both temporary and permanent tariff scenarios, output decreases due to higher costs and lower export demand via appreciation. ### Findings on industrial policies — typology and mechanisms - Typology: - Micro industrial policies = sector/firm‑level measures (production/export subsidies, directed credits, infant‑industry protection, quantitative restrictions, access to lower‑priced SOE inputs). - Macro industrial policies = economy‑wide macro/financial policies implemented with industrial objectives (e.g., foreign reserve accumulation, financial repression paired with capital flow restrictions). - Micro policies: - Effects on aggregate productivity ambiguous: can raise productivity via increasing returns/learning-by-doing or reduce productivity via misallocation and rent‑seeking. - CA impact depends on whether productivity change is positive/negative and temporary/permanent: - Positive | Temporary → CA ↑ - Positive | Permanent → CA ↓ - Negative | Temporary → CA ↓ - Negative | Permanent → CA ↑ - Financing matters: deficit‑financed subsidies tend to reduce public saving and lower the CA; consumption‑tax‑financed subsidies can raise household saving and modestly increase CA but lower consumption. - Empirical evidence at sector level: subsidies can boost exports (around 8 percent in G20 emerging market sectoral evidence) but competitiveness gains are temporary. - Macro policies: - Foreign reserve accumulation with capital flow management: - Governments buy foreign assets using domestic debt issuance; with capital account restrictions, private sector cannot offset; financial account surplus → current account surplus and real exchange rate depreciation. - Such policies can depress domestic consumption and investment even as exports rise. - Financial repression and forced saving with capital controls: - Measures (interest rate caps, credit allocation, dividend restrictions, forced saving) can create wedges between domestic and world interest rates (Δ푟푟 expressions in the text) and alter saving–investment outcomes. - Net CA outcome depends on whether forced saving leaks abroad or finances domestic investment; CA can improve if forced saving leaks to the rest of the world. - Combining foreign reserve accumulation, capital controls, and financial repression can magnify CA effects at the cost of suppressed domestic absorption. ### Model simulations (GIMF) — illustrative quantitative results - Model: IMF’s Global Integrated Monetary and Fiscal Model (GIMF) with eight regions and global value chain features. - Saving‑glut scenario: - Private saving increases by 2 percent of GDP over five years in hypothetical “Saving Glut” economies → their CA increases by about 1 percent over same horizon; world interest rates fall and spill over to “Major recipient”. - Fiscal deficit scenario: - Fiscal deficit increase of 2 percent of GDP for 5 years in “Major Recipient” → its CA falls by up to 0.5 percent of GDP; CA in “Saving Glut” economies rises. - Tariff scenarios: - Temporary tariffs: increase CA. - Permanent tariffs (10 percent unilateral increase expected permanent): require immediate exchange rate appreciation; when revenues transferred to households CA broadly neutral (investment decline offsets lower saving); when revenues used to pay down government debt CA modestly increases via fiscal channel. - Under both tariff scenarios output decreases due to higher intermediate/final costs and lower exports via appreciation. - Micro policy productivity shocks (permanent 1 percent tradables productivity boost): - Modest REER depreciation, medium‑term export boost, household saving declines, consumption and imports rise, CA falls. - Micro policy with misallocation (tradables up, non‑tradables down lowering TFP by about ½ percentage points): - CA largely unchanged; modest improvement driven by falling consumption and import compression. - Permanent subsidy (1 percent of GDP annually lowering tradable investment price): - Deficit‑financed: CA falls sharply as investment rises and public saving declines; private saving increases but not enough. - Consumption‑tax financed: CA becomes modestly positive due to higher household saving though domestic consumption is lower. ### Empirical evidence — summary points - Standard determinants: - Cyclical factors: output gaps and terms‑of‑trade changes matter short‑run. - Structural factors: demographics, expected growth, financial structure influence medium‑term saving and investment. - Policy factors: fiscal deficits tend to widen CA deficits; social insurance expansion reduces household precautionary saving and CA. - Financial cycle: global risk‑off episodes drive capital to safe‑asset suppliers (e.g., US) with spillovers to EMs; push and pull factors interact with country characteristics. - Tariff and trade‑barrier evidence: - Mixed and often small effects on trade balance and CA. - Temporary tariff increases can slightly improve trade balance; permanent changes show no statistically significant effect in US case. - Gravity‑model aggregate import/export barriers show no effect of import barriers and negligible impact of export barriers on CA. - Trade policy uncertainty can delay investment and increase precautionary saving → small temporary CA increase. - High persistence and retaliation in tariffs limit behavioral adjustments. - Industrial policy evidence: - Empirical analysis limited by data gaps and heterogeneity of measures. - Broad indices (NIPO) yield insignificant or economically small coefficients on CA at the aggregate level; some sectoral impacts are clearer. - Macro industrial policies (sustained FX intervention with closed capital accounts, repressive financial policies) show meaningful CA increases empirically. ### Risks, stock imbalances, and systemic spillovers - Stocks and valuation: - Persistent CA imbalances accumulate large NIIPs: China, Germany, Japan each held net foreign assets equivalent to 3–3.5 percent of global GDP in 2024. - US NIIP about -25 percent of global GDP in 2024; valuation gains (e.g., US equities outperformance) have markedly affected the US NIIP. - Valuation effects can dominate flow dynamics for some economies. - Financial vulnerabilities: - Large gross external positions create currency, maturity, and rate‑of‑return mismatches that amplify shocks (examples: Asian financial crisis; 2008 Iceland/Ireland/UK). - Even small adjustments in a historically large NIIP (US at -25 percent) could have outsized spillovers requiring larger adjustments elsewhere. - Systemic and political economy risks: - Large surpluses can depress global interest rates and foster risk‑taking abroad. - Adjustment burdens tend to fall disproportionately on deficit countries (except possibly reserve currency issuers). - Distributional effects from trade shifts can fuel protectionism and political tensions. ### Scenarios and policy trade‑offs - Unbalanced Growth (imbalances widen): - Drivers include US fiscal deficits and subdued household saving, AI-driven investment surge; China export support and higher household saving from real estate downturn; Europe weak productivity and low private investment. - Tariff escalation: bilateral tariffs +20 percentage points among US, China, euro area with retaliation → small CA effects but lower global output; if tariffs unilateral rather than reciprocated CA impact positive and modest when revenues pay down debt. - Risks: deficit countries vulnerable to abrupt risk appetite shifts and term premia increases; surplus countries may intensify trade tensions and risk disorderly rebalancing. - Reforms aimed at domestic rebalancing (imbalances narrow): - Simultaneous policies modeled: - US: fiscal reform lowering deficit by 1 percent of GDP after five years; US public debt declines by 25 percentage points of GDP in long term; tariff rollback reducing effective US import tariffs by about 10 percentage points; trading partners remove tariffs on US exports (US exports to China see a decrease of about 20 percentage points); two‑standard‑deviation decrease in global economic policy uncertainty. - China: short‑term fiscal expansion of 0.5 percent of GDP to boost social spending and residential investment, lowering household saving; lower industrial policy support raising productivity; yuan allowed to adjust. - Europe: public and private investment increases to reach 1 percent of GDP by 2026 and remain until 2030; TFP and potential output rise. - Model outcomes: - Global imbalances decline and global GDP rises. - US current account balance increases by 0.5 percent of GDP by scenario end. - China’s current account balance declines by up to 1.3 percent of GDP. - Output equal to or above baseline in US, China, euro area; GDP rises most above baseline in China and euro area. - Spillovers: reforms in China and euro area account for about half of the overall increase in US CA in the scenario. - Risk of asymmetric adjustment: one‑sided efforts can harm countries that do not adjust and may damp global growth. ### Policy implications and recommendations for authorities - Primary prescription: domestic rebalancing through macroeconomic and structural reforms that support productivity growth and resilient domestic demand; industrial and trade policies cannot substitute for such rebalancing. - Evaluate trade and industrial policies within the saving–investment framework and account for macro costs, distributional effects, and cross‑border spillovers. - Specific observations: - Tariffs: limited and often temporary CA effects, with potential output costs; larger CA effects only where exchange rates cannot adjust or when revenues finance debt reduction. - Micro industrial policies: ambiguous aggregate CA effects; limited on average empirically; CA impacts operate via productivity and fiscal channels. - Macro industrial policies: economy‑wide policies (e.g., FX intervention with capital controls, financial repression) can materially and persistently affect CA by suppressing domestic absorption. - Surveillance and data priorities: - Improve data and transparency on industrial and trade policies. - Strengthen integration of capital flow and stock dynamics into external assessments. - Refine EBA and REER models; explore dynamic/multilateral models for largest economies. - Better integrate external sector analysis into Article IV surveillance and multilateral fora; support international policy dialogue (G7/G20, Study Group). ### Role of the IMF / surveillance implications - Fund mandate centers on promoting international monetary cooperation, exchange stability, balanced growth of international trade, and effective operation of the international monetary system. - Surveillance modalities: - Bilateral (Article IV) surveillance includes External Sector Assessments (ESAs) on CA, REER, capital flows, reserves, and NIIP. - Multilateral surveillance (ESR, WEO, GFSR) assesses largest members (85 percent of global GDP) multilaterally and supports policy dialogue. - Ongoing Fund efforts: - Refining EBA (fourth review), EBA‑lite, and REER models. - Addressing data gaps (TT‑GA on Global Asymmetries). - Enhancing external sector statistics and forward‑looking ESR in 2026. - Strengthening engagement with G7/G20 Presidencies and Study Group. - Surveillance guidance: - Anchor ESAs in the saving–investment framework. - Evaluate policies that suppress domestic demand or rely on restrictions for macro costs and spillovers. - Complement bilateral advice with outward spillover analysis. ### Issues for discussion (as framed in the paper) - Does the Fund saving–investment framework serve as the appropriate conceptual anchor to monitor and diagnose global imbalances? - Does the paper highlight the main conditions under which industrial and trade policies may impact current account balances? - Does domestic rebalancing through a better mix of policies contribute to a more orderly resolution of global imbalances? - Is further analysis needed to enhance the Fund’s role in assessing global imbalances, including addressing statistical and methodological gaps, refining the EBA, and analyzing capital/financial flows and stock dynamics? *Prepared by an interdepartmental staff team from the Research (RES) and Strategy, Policy and Review (SPR) departments.* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Overview and context - After more than a decade of steady decline, global imbalances have widened in recent years. - Current account surpluses and deficits can be appropriate when they reflect economic fundamentals and desirable policies, but buildup and persistence of large imbalances raise concerns when driven by policy distortions and unwind in a disorderly manner. - The expansion of industrial policies and the rise in trade restrictions—often motivated by imbalances themselves—have intensified debate on causes and consequences of global imbalances, despite limited analytical and empirical clarity on how both policies affect the current account. - The recent widening of global imbalances is a reversal of the steady narrowing since the global financial crisis. ### Key stylized facts - Global imbalances are highly concentrated among a small group of systemic economies and display greater persistence. - Trade balances remain a significant component of overall current account balances. - Current account surpluses and deficits have accumulated into historically large stock imbalances, increasing vulnerability to financial shocks. - Valuation effects—from movements in exchange rates and asset prices—now play a larger role in changes in external wealth, particularly for economies with large gross cross-border positions. ### Analytical framework - Builds on the intertemporal approach: external balances are the outcome of national saving and domestic investment; changes in current account balances require understanding why and how forward-looking saving and investment decisions change in response to policy or shocks. - Framework encompasses cyclical factors, macroeconomic and structural fundamentals, and key economic policies as drivers of the current account, and demonstrates how spillovers propagate. - Framework underpins the Fund’s External Balance Assessment (EBA) and is expanded to examine implications of industrial and trade policy for saving, investment, and the current account. ### Findings on trade and industrial policies - Trade and industrial policies can affect external balances in fundamentally different ways shaped by their duration and scope. - Tariffs: - Temporary tariffs can increase the current account. - Permanent tariffs are broadly neutral; any modest effects operate mainly through fiscal channels. - Industrial policies: - Distinguish “micro industrial policies” (targeted at firms or sectors) and “macro industrial policies” (deployed economy-wide). - Micro industrial policies tend to have ambiguous and limited effects: they increase the current account insofar as the policy “fails” or generates aggregate productivity losses through sectoral misallocation. - Macro industrial policies—such as foreign reserve accumulation or financial repression combined with policy-induced restrictions (e.g., capital flow management measures)—can have a more material effect on external balances, often suppressing domestic consumption and increasing external deficits elsewhere. - Some measures (e.g., foreign reserve accumulation, capital flow management) may be deployed for appropriate macroeconomic stabilization objectives; the paper does not provide a normative assessment of these policies. ### Model simulations and empirical evidence - Illustrative model simulations and existing empirical evidence corroborate the analytical conclusions and highlight policy trade-offs. - Policies that raise the current account often do so by suppressing consumption, output, or investment. - Policies that support productivity and domestic demand tend to lower surpluses or widen deficits. - Empirical evidence suggests that tariffs and industrial policies have, on average, small effects on current account balances—reflecting both how they are applied and interactions with macroeconomic channels captured in standard empirical models. ### Macroeconomic drivers and risks - Traditional macroeconomic policies remain significant drivers of imbalances, though certain industrial policies could play a role. - Trade restrictions play a limited role in correcting imbalances, especially under flexible exchange rates, but can worsen output. - Prolonged imbalances or those that build alongside financial vulnerabilities risk disorderly adjustment with severe economic consequences. - Policy actions that remove domestic distortions through fiscal and structural reforms can simultaneously narrow imbalances while enhancing global output. ### Scenarios and policy trade-offs - Scenarios show how different combinations of fiscal, structural, and industrial policies could narrow or widen global imbalances. - Global imbalances could widen further if existing trends continue or are amplified in major economies; without corrective policy actions, adjustments are unlikely to be orderly. - Use of tariffs to address imbalances has limited impact on current account balances but generates disruptions and output losses. - Simultaneous domestic growth-enhancing reforms can materially narrow imbalances while boosting global output. ### Role of the Fund and surveillance implications - Fund surveillance is central to engaging members on policies that address external imbalances and promote economic and financial stability; this focus is anchored in the Fund’s founding mandate and legal framework. - Resolving global imbalances requires policy adjustment by both surplus and deficit countries; adjustment ultimately depends on domestic policy actions, preferably synchronized. - To strengthen engagement, the Fund is pursuing a multi-pronged approach: - refining its External Balance Assessment model; - advancing the Comprehensive Surveillance Review; - enhancing external sector statistics; - undertaking further analytical work on stock imbalances and financial stability; - supporting international policy dialogue in multilateral fora. - Reforms are challenging and can be disruptive in the short term; the alternative—continued widening of imbalances—is also economically disruptive and ultimately more costly. ### Organizational and authorship note - Approved By Pierre-Olivier Gourinchas and Christian Mumssen. - Prepared by an interdepartmental staff team from the Research (RES) and Strategy, Policy and Review (SPR) departments, with contributions from the Legal (LEG) and Statistics (STA) departments; coordinated by Manasa Patnam (RES). *Prepared by an interdepartmental staff team from the Research (RES) and Strategy, Policy and Review (SPR) departments.* ### 10. Current account surpluses or deficits need not be a cause for concern. Some external ### 10. Current account surpluses or deficits need not be a cause for concern. Some external ### Conceptual framework: warranted vs excessive external balances; EBA methodology - Current account surpluses or deficits can be consistent with economic fundamentals and desirable policies (for example, young or rapidly growing economies financing development with foreign capital). - Excessive balances arise when underlying forces are amplified by policy-induced distortions that systematically raise saving or depress investment—or vice versa—beyond levels implied by fundamentals and desirable policies. - The challenge is distinguishing warranted balances (or “norms”) from excessive balances caused by policy distortions (e.g., excess fiscal deficit) and other factors. - The IMF operationalizes excessive balances through its External Balance Assessment (EBA) methodology (Box 1). - Trade and industrial policies can contribute either to the norm (if desirable) or to the excess; the framework developed in subsequent sections conceptualizes how these factors affect the current account without taking a position on the desirability of the policies themselves. - EBA methodology: three main components - (i) a cross-country regression model to benchmark the current account; - (ii) regression models to benchmark the real effective exchange rate (REER); - (iii) the external sustainability (ES) approach for cases where risks arising from large net international debtor positions may be relevant. - Relative weight: Generally, greater weight is given to the current account model because real exchange rates tend to be more volatile and harder to explain econometrically. - EBA outputs - (i) Current account norm: An estimate of the current account balance consistent with medium-term fundamentals (퐹퐹푖푖푖푖, such as demographics, output per worker, expected growth) and desirable policies (푃푃푖푖푖푖∗). - (ii) Current account gap: The difference between the realized current account after adjusting for cyclical and other short-term factors (퐶퐶푖푖푖푖) and the norm. A positive gap indicates a balance that is larger (more surplus or less deficit) than warranted by fundamentals and desirable policies. - (iii) Policy gap and residual: The current account gap equals the sum of model-identified policy gap and the regression residual. The policy gap quantifies how much of the excess balance is due to deviations of key policy variables—fiscal stance, foreign reserve accumulation, capital controls, and public health spending (a proxy for social protection)—from desirable levels. The residual captures country features or policy distortions not explicitly incorporated in the model. - Role of staff judgment - EBA model outputs are combined with Fund staff judgment to arrive at final staff external sector assessments (ESA). - Adjustors may be applied where models do not fully capture relevant characteristics (examples: accounting for the effects of the pandemic, adjustments for countries with significantly lower life expectancies). These adjustors should be analytically grounded, applied evenhandedly, and multilaterally consistent. ### A. Evolution of global imbalances — patterns, concentration, persistence, and composition - Historical recurrence and shifting roles - Global imbalances have been a recurrent feature of the global economy since the 1870s; countries have switched positions over time (example: United Kingdom ran sustained surpluses prior to World War II and shifted into structural deficit after 1945; US transitioned from surplus to deficit in the 1970s while Germany and Japan moved into surplus). - Concentration - Four economies—the US, China, Germany, and Japan—account for roughly two-thirds of global imbalances. - The US deficit—equivalent to 4 percent of GDP as of 2024—has been financed by capital inflows and portfolio investors seeking dollar assets. - Germany and Japan’s surpluses have been driven by high saving rates, joined by substantial surpluses in China beginning in the 2000s. - Oil-exporting countries’ surpluses fluctuate with commodity prices, creating episodic contributions to global imbalances. - Persistence - Earlier decades featured more cyclical surpluses and deficits; since the 1980s average duration of a deficit or surplus spell roughly doubled. - The share of countries where deficits or surpluses remain for over three years has increased since the late 1980s and remained at the elevated level since. - Composition of current account balances - Trade in goods and services remains the largest component of current account balances; other components (primary income and secondary income) typically attenuate magnitude rather than reverse sign. - Primary income flows have grown in importance over recent decades—particularly for financial centers and advanced economies with large cross-border asset positions—partially offsetting goods balances. - Rapid growth in digital services, royalties from intellectual property, and professional services complicates measurement and cross-country comparison of current account balances. - Stocks and valuation effects - Persistent current account imbalances accumulate into large net foreign asset positions: China, Germany, and Japan each held net foreign assets equivalent to 3–3.5 percent of global GDP in 2024. - Persistent deficits have built up into large net liability positions, most notably in the US where the NIIP stands at about -25 percent of global GDP in 2024. - Valuation effects—arising from exchange rate movements, asset price changes, and differences in portfolio composition—can amplify or offset flow dynamics. Since the 2000s valuation changes have become more important than trade flows in explaining movements in the NIIP for some economies. ### B. Risks from global imbalances and historical episodes - Broad risk assessment - Large current account surpluses and deficits pose risks to global economic stability especially if they unwind through a disorderly adjustment. - Over time, large deficits or surpluses can amplify vulnerabilities to shocks. - Orderly adjustment typically involves gradual narrowing through shifts in saving and investment behavior, with implicit relative price adjustments and limited macroeconomic disruption. - Disorderly adjustment is often associated with abrupt capital flow reversals, sharp asset price corrections, and deep economic downturns. - Historical illustrations - Plaza Accord (mid-1980s) - Characterized by large and widening current account balances (US deficit, surpluses in Japan and Germany). - Policy response: coordinated macroeconomic action including the May 1985 Bonn Summit and September 1985 Plaza Accord with coordinated currency intervention. - Outcome: gradual narrowing of external balances driven in part by fiscal and monetary adjustments without significant global growth slowdown; domestic costs for some countries (debated example: Japan’s “lost decades” attribution). - Global Financial Crisis (GFC) - Pre-crisis: large current account deficits in the US and parts of Europe matched by persistent surpluses in emerging Asia and oil exporters, alongside rapid growth in cross-border financial positions. - Underlying determinants: closely intertwined with financial excesses—credit booms, rising leverage, risk-taking in global banking, growing cross-border exposures. - Adjustment during crisis: sharp contractions in domestic demand, collapses in trade volumes, sudden reversals of capital flows; policy coordination played a more limited initial role. - Financial risks from large stocks (Box 3) - Large gross stocks of international assets and liabilities generate risks when mismatches arise across currency denomination, maturity, or rate of return, even if net positions appear moderate. - Currency mismatches are a key source of vulnerability (example: Asian financial crisis—Thailand, Indonesia, Korea—where depreciations raised domestic-currency value of foreign-currency liabilities). - Mismatches can amplify shocks through valuation effects, income flows, and balance-sheet channels, increasing risk of abrupt external adjustment. - Systemic spillovers - Large current account deficits expose economies to external financing risks with negative spillovers globally. - Insufficient saving—often driven by fiscal deficits—can fuel consumption booms financed by external borrowing, heightening rollover risk, exchange rate volatility, and vulnerability to sudden stops. - For systemically important economies, a “sudden stop” in financing can generate sizeable spillovers through trade, financial, and confidence channels. - Large deficits in countries with extensive cross-border financial links increase systemic risk and may trigger rapid cross-border financial contagion. *International Monetary Fund — Understanding Global Imbalances (excerpt).* ### Box 3. Financial Risks from Large External Stocks of Assets and Liabilities (concluded) ### Box 3. Financial Risks from Large External Stocks of Assets and Liabilities (concluded) ### Financial vulnerabilities from large gross external positions - Exchange-rate exposure: shares of dollar-denominated external debt—such as Argentina and Türkiye—have remained exposed to exchange rate shocks, with depreciations translating quickly into higher debt burdens and capital outflows. - Maturity and rollover mismatches: short-term external liabilities financing longer-term or illiquid assets can create acute liquidity and currency stress when funding markets freeze (example: 2008 episodes in Iceland, Ireland, and the United Kingdom required central bank swap lines and, in some cases, sovereign intervention). - Transmission from gross positions: large gross cross-border positions can transmit financial stress even when net positions or current account balances are relatively small. - Rate-of-return differentials and valuation effects: - The US, despite a persistently negative NIIP, has historically earned higher returns on its foreign assets than it paid on its liabilities—a phenomenon often referred to as “exorbitant privilege.” - This advantage is not guaranteed: shifts in global risk appetite, interest rates, or asset prices could compress return differentials, leading to rapid NIIP deterioration given the scale of US gross positions. - In recent years, the US NIIP has markedly deteriorated because of the strong outperformance of US equities (Figure 7). - Even relatively small adjustments in the US NIIP—at a historically high -25 percent of global GDP—could have outsized spillovers, requiring much larger adjustments in other countries. ### Large current account surpluses: multilateral consequences and persistence - Excess domestic saving in surplus economies, when channeled abroad, can: - Put downward pressure on global interest rates, generating spillovers through eased financing conditions and lower prices in other economies. - Trigger excessive risk-taking or leverage in recipient economies, generating financial vulnerabilities that can spread globally through cross-border linkages, including back to the surplus economy. - Distribution of adjustment costs: - The burden of adjustment tends to fall disproportionately on deficit countries—with the possible exception of reserve currency issuers—which face stronger market-driven pressures than countries with persistently large surpluses. - Net capital outflows can be more ‘sticky’ with consequences for the global economy. - Policy complications for deficit economies: - Lower global interest rates make deficit economies more likely to hit the effective lower bound on interest rates, complicating the use of monetary policy to accommodate demand shocks. - Surpluses arising from higher export competitiveness can have mixed effects: disinflationary benefits for some trading partners facing inflationary pressures, but harm to those facing weak demand or economies specialized in competing industries. - Political economy risks: - Large global imbalances can have distributional implications that fuel protectionist sentiment if trade increases faster than trading partners can reconfigure their economies, potentially undermining support for open markets. ### Conceptual framework: the intertemporal approach to the current account - Framework description: - Models the current account as the outcome of optimal saving and investment decisions by forward-looking agents (firms, households, and governments). - Current account driven by intertemporal trade-offs: households “tilt” consumption toward present or future (life-cycle saving, precautionary saving) and “smooth” consumption via external borrowing or lending; firms invest until expected marginal return equals the equilibrium interest rate. - Real exchange rate, capital flows, current account, and real interest rates are consistent in equilibrium. - Analytical uses: - Forms the analytical basis of the Fund’s EBA methodology and a framework for analyzing how shocks and policies affect current account balances (see Box 1 and Phillips and others 2013). ### Saving-Investment diagram and the “saving glut” example - Two-region illustration (regions A and B): - Region A: low desired saving, high desired investment → high autarky interest rate → initial current account deficit. - Region B: high desired saving, low desired investment → low autarky interest rate → initial current account surplus. - Saving glut mechanism: - A positive shock to saving preferences in region B (e.g., precautionary saving after 1990s crises) shifts its saving schedule outward, lowering the world interest rate and increasing B’s current account surplus while widening A’s deficit. - Historical reference: an important explanation for the rise in global imbalances in the 2000s was high desired savings in some emerging market economies (Bernanke 2005). ### Standard macroeconomic determinants of the current account - Temporary and cyclical factors: - Exogenous shocks change the time profile of income; increases in uncertainty or declines in expected future growth can increase contemporary saving and shift the saving curve outwards. - Positive terms-of-trade shocks, when temporary, can shift the saving schedule outward and increase the current account. - Macroeconomic and structural fundamentals: - Population aging increases the incentive to save, raising the current account balance. - Large natural resource discoveries make countries richer in the future, decreasing saving but typically worsening the current account (Arezki and others 2017). - GDP per capita and capital scarcity: developing economies may import capital and run current account deficits to finance higher-return domestic investments. - Policy-related factors: - Fiscal policy: a fiscal expansion reduces national saving, lowering the current account balance of that region and raising the world interest rate—potentially resulting in “twin deficits.” - Structural policies (e.g., expanding social safety nets) reduce households’ desire to save, thus lowering the current account. - Joint determination of current account, capital flows, and NIIP: - The intertemporal budget constraint links a country’s net foreign asset position to its current account: for a given external liability stock, solvency requires either future trade surpluses or excess returns on the external portfolio (Gourinchas and Rey 2007; Gourinchas and Rey 2014). - Imbalance in the supply and demand for safe assets can generate net capital flows toward safe-asset issuing countries (Caballero, Farhi and Gourinchas 2008). - Capital flows respond to “push” and “pull” factors; risk-premium shocks from sudden inflows/outflows or loss of market confidence can drive wedges in domestic interest rates and alter current accounts, potentially narrowing imbalances but increasing volatility and financial stability risks (see IMF 2024a; Box 3). ### Trade policies and the current account (uniform tariffs) - Partial equilibrium intuition: unilateral tariffs raise imported goods’ prices, leaving export demand unchanged, suggesting an improvement in trade and current account balances; however, final impact depends on saving and investment responses. - Duration matters: - Temporary tariffs: can increase national saving via postponed consumption and affect the current account (Razin and Svensson 1983). - Permanent tariffs: generally considered current-account neutral in simple intertemporal models where investment does not respond, because there is no intertemporal incentive to change saving. - When investment responds: - Higher imported input costs and lower export demand can depress investment, potentially overturning neutrality (Sen and Turnovsky 1989). - If tariffs improve terms of trade and redistribute revenues to households, real purchasing power rises and saving may fall, muting current account improvement. - Retaliation by other countries would negate terms-of-trade benefits. - Exchange rate adjustment: - Neutrality of permanent tariffs requires exchange rate appreciation to equilibrate export and import demand. - If the exchange rate cannot appreciate (fixed exchange rate or other interventions), permanent tariffs may have a larger positive effect on the current account; otherwise adjustment occurs slowly through non-tradable price increases and gradual real appreciation (Erceg and others 2023). - Temporary vs. structural deficits: - For temporary trade deficits expected to be followed by future surpluses, permanent tariffs can raise saving and shrink the deficit (Dornbusch 1983; Obstfeld 1996). - For countries with permanent deficits funded by an initial positive NIIP or excess returns on net foreign assets (such as the US “exorbitant privilege”), tariff impacts are less predictable and depend on how tariffs reshape the market value of a nation's net financial position (Itskhoki and Mukhin 2025). ### Industrial policies and the current account - Definition and objectives: - Industrial policies are measures to support specific sectors or firms for economic or non-economic objectives, including boosting competitiveness, establishing technological dominance, climate change mitigation, or supply chain resilience (Evenett and others 2024, 2025). - They may be justified to address market failures (externalities, coordination failures, under-provision of public goods), including security considerations. - Macroeconomic channel: - Industrial policies affect the current account through their effects on saving and investment; their prevalence across advanced and emerging market economies necessitates understanding their impact on global imbalances. - Analytical approach: - The framework incorporates industrial policies by mapping how sector- or firm-level support shifts aggregate saving and investment schedules and thereby current account positions. *International Monetary Fund — Box 3. Financial Risks from Large External Stocks of Assets and Liabilities (concluded)* ### 29. Traditionally, industrial policies have been defined as measures targeted at the level of ### ppea2026006 - 29. Traditionally, industrial policies have been defined as measures targeted at the level of ### Definitions and analytical typology - Industrial policies traditionally defined as measures targeted at specific firms and sectors, including production or export subsidies, directed or subsidized credits, “infant-industry” trade protection, quantitative restrictions, and access to lower-priced inputs from state-owned enterprises (IMF 2024b). - Financing channels noted: budgetary subventions or cross-subsidies from other industries and households. - Broad-based micro measures also possible (example: R&D tax credits, national development or public investment banks). - This paper expands the sectoral definition by adding a limited set of macroeconomic and financial sector policies with industrial policy objectives: - “Micro” industrial policies = sectoral measures described above. - “Macro” industrial policies = economy‑wide macroeconomic and financial policies implemented with industrial policy objectives; these can have non-neutral sectoral effects by altering relative prices (Warwick 2013). - Example of macro industrial policy: export-led growth strategy operationalized through a combination of real exchange rate depreciation and enforced low domestic demand (Corden 1980; Blanchard and Milesi-Ferretti 2012; Ottonello and others 2024). - Clarifications: - Conventional macro stabilization policies are not considered industrial policy in this analysis. - The micro/macro typology is analytical to illustrate tradeoffs and synergistic cases. ### ‘Micro’ industrial policy: effects on aggregate productivity and the current account - Micro policies can: - Boost productivity and growth by shifting resources toward sectors with increasing returns and learning-by-doing externalities (Lashkaripour and Lugovskyy 2023; Bartelme and others 2025). - Reduce productivity if poorly targeted, by diverting resources from sectors with positive externalities or creating rent-seeking (IMF 2024b; IMF 2025b). - Ambiguity of initial current account (CA) effect depends on whether productivity changes are temporary or permanent: - Temporary negative productivity → households smooth lower current income (saving schedule outward), investment less affected → CA decreases. - Anticipated future negative productivity → higher saving and reduced investment → CA increases. - Table 1. Impact of Micro Industrial Policy-Induced Productivity Shock on the Current Account - Direction of Productivity Shock - Positive | Temporary → CA ↑ - Positive | Permanent → CA ↓ - Negative | Temporary → CA ↓ - Negative | Permanent → CA ↑ - Other channels where micro policies alter the CA: - Policies that boost quantities in export-focused sectors without financial incentives (e.g., state directives to increase output) can: - Push resources into those sectors, reduce profit margins, create relative input shortages in non-tradable sector, raise non-tradable prices → real appreciation → increase investment and lower CA. - Broad-based micro policies or those targeting large industries more likely to affect aggregate variables and the CA through productivity and fiscal channels. - Deficit-financed subsidies can reduce aggregate saving (Ricardian Equivalence unlikely to fully offset). - Timing/type of taxation matters (example: immediate increase in consumption taxes may lower consumption by credit-constrained households, increasing aggregate saving initially). - Ultimate CA impact depends on whether saving rises sufficiently to offset investment increases driven by the subsidy. ### ‘Macro’ industrial policy: mechanisms and current account implications - Macro industrial policies are implemented economy‑wide and often combined with policy-induced restrictions (e.g., capital flow management measures) that limit private-sector offsetting behavior and create a wedge between domestic and world interest rates. - Two example macro industrial policies and their CA channels: - Foreign reserve accumulation with capital flow management measures: - Governments sell domestic debt to private sector and use proceeds to buy foreign assets; with a restricted capital account private sector cannot offset by selling assets to or borrowing from abroad. - Financial account surplus → current account surplus → requires real exchange rate depreciation (Jeanne 2013). - Described wedge: Δ푟푟=푟푟_A′−푟푟_B′<0; depresses investment and expands CA surplus in Region B, while expanding deficit in Region A. - Distinction: sustained, one-way sterilized foreign exchange intervention (FXI) that increases foreign reserves is considered here as macro industrial policy; short-term operations to prevent excessive volatility are not. - Financial repression and forced saving with capital flow management measures: - Measures: legal restrictions on interest rates, credit allocation, capital movements; often combined with forced saving (low social safety net, directed lending, restrictive corporate dividend policies, directives on sovereign wealth fund or exporter revenues). - Financial repression alone shifts households down the saving curve; forced saving shifts desired saving curve right. - With capital outflow restrictions, a positive wedge emerges: Δ푟푟=푟푟_퐴퐴′−푟푟_퐵퐵′>0 as households are prevented from purchasing higher-yielding foreign assets. - Net result can be simultaneous increase in domestic saving and domestic investment, leaving CA largely unchanged in both regions. - CA can improve if forced saving ‘leaks’ to the rest of the world rather than financing domestic investment. - Interactions and combinations: - Combining foreign reserve accumulation with capital controls and financial repression can magnify CA effects while influencing domestic interest rates and investment. - Micro policies increasing export-oriented output need not raise CA if non-tradable prices rise; pairing with forced saving that suppresses non-traded demand can reverse these side effects and increase CA at the cost of suppressing domestic consumption. ### Model-based simulations (GIMF) and key quantitative findings - Method: IMF’s Global Integrated Monetary and Fiscal Model (GIMF) with eight regions, capital accumulation, rigidities, three sectors, and global value chains used to simulate policy interventions. - Broad confirmations and nuances: - Simulations broadly confirm conceptual intuition but real-world frictions produce richer CA dynamics. - Policies that increase CA often do so at the cost of suppressed consumption (via expectations of weaker future output, tariff-imposed fiscal consolidation, resource misallocation, or taxes used to finance industrial policy or financial repression). - Illustrative quantitative scenarios and outcomes: - Saving Glut example: - A shift in saving preferences in hypothetical “Saving Glut” economies that increases private saving by 2 percent of GDP over five years increases their CA balance by about one percent over the same horizon. - This pushes down domestic interest rates and spills over abroad, lowering interest rates in a hypothetical “Major recipient” economy. - Fiscal deficit example: - An increase in the fiscal deficit of 2 percent of GDP for 5 years in the “Major Recipient” economy leads to a fall in their CA balance of up to 0.5 percent of GDP, while it increases the CA balance in the hypothetical “Saving Glut” economies. - Tariff scenarios: - Temporary tariffs: produce expected increase in CA in the model. - Permanent tariffs (10 percent unilateral increase expected to be permanent): - Exchange rate must immediately appreciate to equilibrate imports and exports. - When tariff revenues are redistributed to households as transfers: - Two offsetting effects generate broadly neutral CA effects: i) investment declines (higher costs of intermediate goods and capital; exports fall due to appreciation); ii) saving rate as a share of GDP declines by a similar amount as households consume more from higher government transfers and improved terms of trade despite output declines. - When tariff revenues are used to pay down government debt rather than transferred to households: - Saving rate increases while investment decline remains broadly similar → modest increase in CA, largely reflecting the fiscal channel rather than relative price effects. - Under both temporary and permanent tariff scenarios, output decreases as tariffs raise costs of intermediate and final goods and lower demand for exports via real exchange rate appreciation. ### Implications and analytical takeaways - Industrial policy effects on the CA are multifaceted and depend on: - Whether productivity effects are positive/negative and temporary/permanent. - The breadth of micro measures (economy-wide vs narrow sectors) and financing modalities (deficit financing vs tax-financed). - The use of macro instruments that restrict capital flows or repress financial markets, which can create interest rate wedges (Δ푟푟 expressions above) and alter saving-investment balances. - Policy combinations can produce outcomes (e.g., higher CA) at real economic costs such as suppressed consumption, lower investment, or inflationary pressures in non-tradables. - Model simulations reinforce that non-policy drivers (e.g., exogenous saving preference shifts) and fiscal choices interact with industrial policies to shape CA dynamics. *Source: ppea2026006 - 29.* ### 42. Micro industrial policy can generate macro-relevant effects even when targeted at ### 42. Micro industrial policy can generate macro-relevant effects even when targeted at specific sectors, with implications for the current account ### Model simulations: temporary vs. permanent productivity shocks - Temporary positive productivity shock: - The current account will initially rise, buoyed by high saving. - Permanent productivity shocks — two cases examined: - Productivity-enhancing industrial policy: - Following a permanent 1 percent boost to productivity: - Modest real effective exchange rate depreciation. - Medium-term boost to exports (Figure 13, right panel). - Anticipated gains in income lead household saving to decline. - Consumption and imports rise. - Current account balance falls. - Productivity improvements in the tradables sector can spill over to other sectors via technology diffusion and worker upskilling. - Productivity-reducing industrial policy (misallocation): - Scenario: productivity in tradables increases but declines in non-tradables, lowering overall TFP by about ½ percentage points. - The current account remains largely unchanged (Figure 13, left panel). - Two opposing forces: - Expectations of lower future activity raise desired saving and lower investment. - Real exchange rate appreciation as non-tradables productivity falls. - Net effect: modest improvement in the current account, largely driven by falling consumption and import compression. - Export competitiveness gains from higher tradables productivity are partly offset by misallocation-driven higher costs elsewhere. ### Source of fiscal financing for industrial subsidies and current account effects - Permanent subsidy considered: reduces the price of investment in the tradable sector amounting to 1 percent of GDP each year. - Deficit-financed investment subsidy: - Current account balance falls sharply as investment increases and public saving declines. - Private saving increases but not enough to offset the decline in the current account balance. - In the debt financing case, it is assumed that the deficit is larger due to the subsidy for the first 40 years of the simulation, before the deficit target reverts to its steady state value. - Consumption tax-financed investment subsidy: - Consumption responds more negatively, particularly given households that cannot “smooth” through the higher tax burden. - Current account balance becomes modestly positive due to higher household saving (Figure 14, left panel). - Other financing mechanisms that place a heavy burden on households, such as lower targeted transfers, would operate similarly. - While output and the current account balance may be higher, domestic consumption is lower than in a base case without subsidies (Figure 14, right panel). ### Macro industrial policy: foreign reserve accumulation and capital controls - Combination of foreign reserve accumulation and capital controls can increase the current account at the cost of lower domestic consumption. - Mechanism: - Policies generate a persistently lower real exchange rate, improving export competitiveness but possibly hurting domestically focused sectors. - To sustain a persistently weaker currency, authorities must incentivize households to finance the accumulation of foreign assets and prevent them from selling privately held foreign assets. - Debt-financed reserve accumulation requires higher domestic interest rates to incentivize higher saving and capital controls to prevent private selling of foreign assets as the exchange rate depreciates. - These policies reduce consumption and domestic investment even as the current account and exports increase, leaving overall GDP little changed (Figure 15). - To offset the increase in domestic interest rates from higher domestic debt issuance, reserve accumulation can be combined with forced saving policies that further suppress consumption. - Forced saving reduces real interest rates, which in turn limits the reduction in investment that results from foreign reserve accumulation and capital controls. - In GIMF, this is simulated as a shock to the UIP condition that incentivizes the net accumulation of foreign assets for a given interest rate differential. ### Empirical evidence — overview and standard drivers of the current account - Empirical literature groups determinants into cyclical, structural, and policy factors (as operationalized in the IMF’s EBA). - Cyclical/temporary factors: - Output gaps and changes to terms-of-trade relative to trend influence the current account in the short run. - An increase in the output gap reduces the current account balance (higher investment, lower saving). - Short-term terms-of-trade improvements increase the current account as temporary income raises contemporaneous saving. - Macroeconomic and structural fundamentals: - Demographics, financial structure, and expected growth influence saving and investment over time. - Prime-aged savers typically accumulate more wealth to prepare for longer retirement. - Expected output growth tends to lower current account balances because higher expected returns raise investment while consumption-smoothing households reduce saving. - Empirical evidence from technology and supply shocks confirms that productivity gains often stimulate consumption and investment enough to reduce current account balances. - Policy-related factors: - Fiscal policy, social insurance (e.g., healthcare provision), and financial policies (credit gaps) shape national saving and investment, thus affecting current accounts. - Higher budget deficits often widen current account deficits when households do not fully offset government borrowing. - Financial factors: - Global risk-off episodes drive capital toward safe asset suppliers (primarily the United States), with negative spillovers on emerging markets. - Push and pull factors related to capital flows influence the current account mainly via the interest rate channel. - During upswings of the global financial cycle—low volatility and low interest rates—capital flows into emerging market economies financing their current accounts. - The relative role of U.S. monetary policy versus global risk appetite remains debated. - Country-specific characteristics mediate the effects of global financial factors (e.g., net debtors in safe assets, financial openness, exchange rate regime). ### Empirical evidence — tariffs, trade barriers, and industrial policies - Tariffs and trade barriers: - Empirical evidence on tariff impacts on the current account is mixed; recent studies find small to negligible effects on the trade balance. - Distinguishing temporary versus permanent shocks is crucial: - Temporary increases in certain tariffs have been found to improve the trade balance slightly. - Permanent changes have no statistically significant effects in the case of the US. - Aggregate import and export barriers estimated using gravity models show no effect of import barriers and an economically negligible impact of export barriers on current accounts. - Trade policy uncertainty can delay investment and durable goods expenditures while prompting precautionary saving, causing a small temporary increase in the current account. - High persistence of tariffs (1970–2024 distribution) and frequent retaliation limit behavioral adjustment and dampen effects on the current account. - Given their perceived permanence and retaliation, tariff changes empirically behave more like global shocks than country-specific shocks. - Industrial policies: - The relationship between industrial policies and the current account is empirically underexplored due to limited, inconsistent, and non-comparable data on industrial policies and trade barriers. - Preliminary evidence using broad indices from the New Industrial Policy Observatory (NIPO): - Introducing an index of the number of industrial policy measures relative to the sample average yields insignificant coefficients. - Using a categorical variable for quintiles yields an economically small but statistically significant negative coefficient. - Interactions with trade openness and capital account openness yield small positive and insignificant coefficients, respectively. - Evidence is clearer for specific industrial policy instruments’ impacts on sectoral imbalances, but these do not directly extrapolate to aggregate current account effects. *UNDERSTANDING GLOBAL IMBALANCES, INTERNATIONAL MONETARY FUND* ### 52. Certain features of micro industrial policies may explain the limited, in some cases ### ppea2026006 - 52. Certain features of micro industrial policies may explain the limited, in some cases ### Features of micro industrial policies and effects on the current account - Micro industrial policies are targeted and normally affect only a limited number of sectors; cumulative stock of interventions can be substantial but difficult to measure. - Recent research: a boost to competitiveness in targeted sectors affects the composition of trade but "does not generate identifiable aggregate trade impacts" (Rotunno and Ruta 2024). - Evidence shows that when micro industrial policies affect aggregate productivity, the impact tends to be negative due to resource misallocation, which would increase the current account surplus. - Overall conclusion: micro industrial policy has either limited or positive impacts on the current account. ### Cross-country and sectoral evidence on subsidies and competitiveness - Emerging cross-country evidence on subsidies indicates an export-boosting effect of around 8 percent in G20 emerging market economies at the sectoral level (Rotunno and Ruta 2024). - Competitiveness gains from such subsidies are temporary (Huang and others 2025). - Complementary country- and industry-specific evidence exists (Lane 2025; Girma and others 2009; Kalouptsidi 2018). ### Macro industrial policy and current account impacts - Macro industrial policy is found to meaningfully increase the current account. - Interpretation: such policies can reflect a mercantilist motive—deliberate devaluation to promote export-led growth with large-scale foreign reserve accumulation as the operative instrument (Rodrik 2008; Aizenman and Lee 2007; Korinek and Servén 2016). - Empirical findings: - Persistent foreign exchange intervention coupled with a relatively closed capital account lowers the real exchange rate durably and increases the current account (Choi and Taylor 2022). - Earlier work links stronger real exchange rates to weaker external balances (Chinn and Prasad 2003). - Countries exhibiting “fear of appreciation” experience slower current account adjustment and more persistent surpluses (Levy-Yeyati and others 2013; Bergin and others 2025). - Official reserve purchases by emerging market central banks have driven a substantial portion of global current account imbalances (Gagnon 2012). - IMF EBA models estimate a positive effect of foreign exchange interventions (interacted with degree of capital account openness) on the current account. - Cross-country studies indicate countries employing significant repressive financial policies are more likely to run current account surpluses (Johansson and Wang 2012; Wang 2020). ### Explanatory power of trade barriers within EBA specifications - Trade barriers may be swamped by other determinants of the current account because some channels (e.g., productivity shocks proxied by expected GDP growth, fiscal policy) are already accounted for in standard current account specifications. - Empirical finding: trade barriers yield only marginal gains in the fitted variance when incorporated into the full EBA specification (together with other macroeconomic variables), indicating existing variables capture much of their explanatory power (Figure 19). - Empirical challenges remain: endogeneity concerns, persistence of trade barrier shifts, heterogeneous impacts of granular policies. ### Trade/industrial policies and the current account–REER relationship - Trade and industrial policies can alter the response of the current account to the real effective exchange rate (REER). - Measures that raise trade costs (tariffs, non-tariff barriers, payment restrictions, industrial policies) could dampen the medium-term sensitivity of the current account to the REER by narrowing scope for adjustment through trade volumes (Edwards 2004). - Tariffs can trigger REER appreciation that endogenously offsets their impact on the current account because higher domestic prices reduce competitiveness (Jeanne and Son 2024). - Policy-induced frictions complicate assessments of countries’ external positions and equilibrium exchange rates. ### Scenarios for the evolution of current account balances — A. How could imbalances continue to widen? (Unbalanced Growth) - Drivers of continued widening: - In the US: historically high fiscal deficits and subdued household saving; rapid acceleration in AI adoption leading to surge in business investment could further widen US current account deficit. - In China: growth driven by net exports, additional policy support for exporting sector funded by reduced transfers to households; prolongation of real estate downturn causing higher household saving and real exchange rate depreciation — China’s current account balance increases further. - In Europe: lagging productivity growth, lower innovation, lack of access to equity funding, persistently low private investment. - Cross-border spillovers: widening domestic imbalances reinforce global imbalances through trade, financial, and exchange-rate channels; large portion of widening in regional current accounts is driven by shocks generated abroad. - Tariff escalation scenario: - Bilateral tariffs increased by 20 percentage points above current levels in US, China, and euro area; retaliation is reciprocated. - Model outcome: small effect on current account balances in all regions but a reduction in global output; net effect is global output little changed relative to baseline. - Footnote: if tariffs were unilaterally imposed rather than reciprocated, current account impact would be positive and modest only when tariff revenues were used to pay down government debt. - Risks from prolonged widening: - Deficit economies face exposure to abrupt shifts in risk appetite, higher term premia, or reassessment of credit risk leading to sharper-than-expected compression in domestic absorption. - Surplus economies with weak domestic demand could intensify trade tensions and trigger damaging trade policy responses; increased uncertainty could reduce risk appetite and raise likelihood of disorderly rebalancing. ### Scenarios for the evolution of current account balances — B. How can imbalances narrow? (Reforms aimed at domestic rebalancing) - Mode of adjustment matters: simultaneous forward-looking policy actions facilitate gradual rebalancing with lower macroeconomic costs; imbalances that build alongside financial vulnerabilities risk disorderly unwinding. - Illustrative simultaneous domestic policy reforms and modeled assumptions: - United States fiscal reform and tariff rollback: - Fiscal reforms lower the fiscal deficit by 1 percent of GDP after five years. - US public debt declines by 25 percentage points of GDP in the long term. - Tariffs imposed since January 2025 are permanently removed, reducing effective tariff rates on US imports by about 10 percentage points relative to the current baseline. - Trading partners also remove tariffs on US exports; US exports to China see a decrease in effective tariff rates of about 20 percentage points. - A two-standard-deviation decrease in the global economic policy uncertainty measure in Davis (2016). - China tilting toward consumption-led growth: - Short-term fiscal expansion of 0.5 percent of GDP boosts social spending and supports residential investment, contributing to a fall in household saving. - Lower industrial policy support reduces economic distortions and misallocation and contributes to rising business dynamism and higher economy-wide productivity. - The yuan is allowed to adjust in response to these policies. - Europe structural reforms and investment boost: - Public and private investment increases in the euro area, reaching 1 percent of GDP by 2026 and stays at that level until 2030. - Total factor productivity improves and combined with capital deepening increases potential output permanently. - Model outcomes: - Net result: global imbalances decline alongside higher GDP. - US current account balance increases by 0.5 percent of GDP by the end of the scenario. - China’s current account balance declines by up to 1.3 percent of GDP. - Output is equal to or higher than baseline in US, China, and euro area; GDP rises most above baseline in China and the euro area given sizable productivity gains. - Spillover effects: - Reforms predominantly reduce imbalances in the home country but create important synergies abroad (e.g., China broad reform and euro area productivity improvements account for about half of the overall increase in the US current account balance over the scenario horizon). - Risks of asymmetric adjustment: - One-sided efforts to reduce imbalances can adversely affect countries that do not tackle imbalances. - Countries continuing to run large external or domestic deficits, or with high existing stock vulnerabilities, could face higher financing costs threatening fiscal sustainability. - Adjustment undertaken only by deficit countries could dampen global growth and amplify deflationary forces in surplus countries. ### Role of the Fund in facilitating international adjustment - The Fund’s mandate (Article I of the Articles of Agreement) includes promoting international monetary cooperation and exchange stability, facilitating expansion and balanced growth of international trade, and assisting members in establishing a multilateral payments system. - Fund powers: oversight (surveillance, oversight of members’ exchange systems), financial assistance, and advisory powers (financial and technical services) aimed at promoting stability of the international monetary system. - Surveillance modalities: - Bilateral surveillance: - Focuses on individual member countries, identifying vulnerabilities and imbalances at the country level. - Article IV consultations assess whether a member’s domestic and external policies promote balance of payments stability and domestic stability, covering exchange rate, monetary, fiscal, financial sector policies, and other policies significantly influencing balance of payments or domestic stability. - Multilateral surveillance: - Focuses on global economic and financial developments and the outlook for the global economy, including risks to global economic and financial stability that bear on the IMS. - Assesses spillovers from individual members’ policies that may significantly influence the effective operation of the IMS. - The 2012 Integrated Surveillance Decision (ISD) reinforces integration of bilateral and multilateral surveillance and expands the scope of Article IV Consultations to discuss regional and global spillovers and supports multilateral surveillance through “flagships” such as the World Economic Outlook, the Global Financial Stability Report, and the External Sector Report. *Italic: IMF staff summary of content unit ppea2026006 (section 52 and surrounding sections) from the provided PDF content* ### Box 4. The Fund’s Evolving Role in Global Imbalances ### Box 4. The Fund’s Evolving Role in Global Imbalances ### Historical evolution and institutional milestones - Under the Bretton Woods system, Fund activities focused primarily on maintaining external stability through the par value system, the fixed-but-adjustable exchange rate system. - Following the system’s collapse in the early 1970s, focus shifted to the conduct of domestic policies to secure external stability. - The Second Amendment of the Articles of Agreement in 1978 modified Article IV to require members to collaborate to promote a stable system of exchange rates and introduced obligations with respect to members’ domestic policies. - The Second Amendment established the basis for the Fund’s mandate for multilateral surveillance: the Fund “shall oversee the functioning of the international monetary system in order to ensure its effective operation”. - Coverage of global imbalances and international spillovers from domestic policy (mis)settings increased gradually from the mid-2000s and adopted a more systemic perspective after the GFC. - The 2012 Integrated Surveillance Decision formalized coverage of spillovers from members’ economic and financial policies in Article IV consultations and sought to better integrate bilateral and multilateral surveillance. - Key Fund initiatives and milestones mentioned in the Box include: Multilateral Consultations (2006–07), Spillover Reports (beginning 2011) and integration into the WEO (2016), External Sector Report (ESR, annually since 2012), and the G20 SSBIG reporting role (since 2017). ### Current three-layered approach to external imbalances (paragraph 69) - Diagnosis: - The Fund collects data on external sector statistics based on the standard framework of the Balance of Payments and International Investment Position Manual, 6th edition, and related standards for data dissemination (the IMF Data Standards Initiatives). - Recent efforts focus on monitoring policy announcements such as on tariffs and industrial policies in collaboration with WTO and Global Trade Alert, as reflected in the WTO-IMF Tariff Tracker and the New Industrial Policy Observatory (NIPO). - Analysis of external imbalances is anchored by the EBA and EBA-lite models, which seek to distinguish “excess” from appropriate balances in a multilaterally consistent and evenhanded manner. - Complementary analytical tools informing the CA norm include the External Sustainability Model, Real Effective Exchange Rate models, Commodity Modules and the External Debt Sustainability Analysis. - Policy advice: - In bilateral surveillance, staff reports include external sector assessments (ESA) based on the models noted above. - The ESA focuses on five key areas: (i) the current account balance, (ii) the real effective exchange rate, (iii) capital flows, (iv) foreign reserves levels, and (v) the net international investment position. - In multilateral surveillance, the ESR assesses the external sector for the largest members, accounting for 85 percent of global GDP, in a multilaterally consistent manner; the report analyzes factors driving global imbalances and provides policy recommendations to address them. - Supporting international policy dialogue: - The ESR and other analyses of global imbalances serve as input to the multilateral policy dialogue promoted by the Fund. - The Fund continues to assist multilateral fora by regularly monitoring and reporting on policy actions and external developments, and will provide enhanced support to the upcoming G7 and G20 Presidencies and the Study Group to develop a shared understanding on the drivers of global imbalances and spillovers of policies and adjustment mechanisms. ### Recent and ongoing initiatives to strengthen ESA and engagement (paragraph 70 and following) - Addressing Data Gaps: - Global current account asymmetry (sum of current account balance across countries) has been rising over time, driven by positive discrepancies in the goods and services balances and negative discrepancies in primary and secondary income balances. - The IMF’s Committee on Balance of Payments Statistics (BOPCOM) established the Task Team on Global Asymmetries (TT-GA). - Preliminary recommendations from TT-GA focus on international collaboration, standardization of methodologies, enhanced global data collection, and improved data collection and survey design; further recommendations will be developed in the near-term. - Refining Analytical Tools: - The fourth EBA Review is ongoing and will strengthen the Fund’s analysis and assessment of excessive imbalances. - Staff are prioritizing improvements to the Current Account (CA) model of the EBA framework with particular attention to NFA benchmarking and demographics; trade barriers are another priority. - The EBA-lite model update is examining the role of policy interventions for the wider membership comprising emerging market and low-income economies. - Medium-term goal: explore feasibility of dynamic models as a complement to the single-equation analysis, focusing on the largest economies with a multilateral (global) approach to incorporate international trade and financial system features and to simulate alternative policy-dependent scenarios. - A revamp of the Real Effective Exchange Rate (REER) models is being explored. - Future analytical work will study capital and financial flows and their links to stock imbalances, and implications for financial stability risks. - Strengthening Policy Advice: - The 2026 Comprehensive Surveillance Review (CSR) will identify gaps in coverage of the external sector in surveillance and provide recommendations to better integrate the ESA into Article IV surveillance. - A diagnostic exercise (including reviews of past Article IV reports and surveys) is underway to inform the Surveillance priorities. - The 2026 External Sector Report (ESR) will shift towards a more forward-looking analysis, assessing risks to the global economy from imbalances and planned medium-term policies under a range of scenarios. - CSR will aim to identify weaknesses and provide suggestions to improve quality and consistency of coverage of outward spillovers in Article IV consultations. - Enhancing Policy Coordination: - Building on the 2006 Multilateral Consultation, the Fund provides a platform for members to exchange views and coordinate policies to mitigate risks and address external imbalances. - The Fund will provide enhanced support to G7 and G20 Presidencies and the Study Group to develop a shared understanding of drivers and spillovers. ### Key analytical conclusions and policy-relevant findings (paragraphs 71–73) - The saving–investment framework remains the appropriate conceptual anchor for analyzing global imbalances; current account positions reflect forward-looking saving and investment decisions shaped by macroeconomic fundamentals, structural characteristics, domestic policies, and different economic structures and systems. - Trade and industrial policies affect external balances primarily through macroeconomic channels and should be analyzed within the broader saving–investment framework rather than in isolation. - Tariffs: - Uniform tariffs tend to have small and often temporary effects on external balances, particularly when perceived as permanent and when exchange rates are flexible. - If the exchange rate is unable to appreciate (for example, due to a fixed exchange rate regime), there may be a larger and positive effect on the current account. - Some modest effects on the current account may materialize when tariffs are temporary or when revenues generated by tariffs are used for fiscal consolidation. - Industrial policies: - Standard (micro) industrial policies, typically targeted at specific sectors, have ambiguous aggregate effects and are found empirically to have limited or modest impacts on current accounts, mainly through productivity and fiscal channels. - Macro industrial policies—economy-wide macroeconomic and financial policies such as capital flow restrictions with sustained foreign exchange intervention to help achieve industrial policy objectives—can have more material and persistent effects on current accounts, typically by suppressing domestic absorption. - Many circumstances exist where such policies may be deployed to achieve appropriate macroeconomic stabilization objectives. - Effective and sustainable adjustment requires domestic rebalancing through macroeconomic and structural policies that support productivity growth and resilient domestic demand; industrial and trade policies cannot substitute for such rebalancing. - External surpluses generated through demand compression or financial repression can exacerbate domestic distortions and shift the burden of adjustment to trading partners. ### Implications for Fund surveillance and priorities going forward (paragraphs 72–73) - External sector assessments should remain firmly anchored in the saving–investment framework. - Policies that affect external balances—particularly those that suppress domestic demand or rely on restrictions—should be evaluated in terms of macroeconomic costs, distributional effects, and cross-border spillovers. - Bilateral advice should be complemented by analysis of outward spillovers given significant spillovers from adjustment in large surplus and deficit economies. - Priorities for future work include: - Improving data and transparency on industrial and trade policies. - Strengthening integration of capital flow and stock dynamics into external assessments. - Further refining analytical tools to capture policy interactions. - Better integrating external sector analysis into Article IV surveillance through the CSR. - The analysis is intended to support coherent and evenhanded surveillance, to help staff assess policy interactions and identify when external balances reflect underlying distortions; it is not intended to establish new Fund policy or create a presumption for or against particular policy instruments. ### Issues for discussion (paragraph 74) - Do Directors agree that the Fund saving-investment framework serves as a conceptual anchor to monitor and diagnose global imbalances? - Do Directors agree that the paper highlights the main conditions under which industrial and trade policies may impact current account balances? - Do Directors agree that domestic rebalancing, through a better mix of policies, can contribute to a more orderly resolution to global imbalances? - Do Directors agree that there is a need for further analysis to enhance the Fund’s role in assessing global imbalances, including tackling statistical and methodological gaps, further work on refining the EBA, and analyzing the role of capital and financial flows/stocks? *Source: IMF, World Economic Outlook; and IMF staff calculations* ### References ### ppea2026006 - References ### Precautionary reserves, capital flows, and reserve accumulation - Aizenman, Joshua, and Jaewoo Lee, 2007, “International Reserves: Precautionary versus Mercantilist Views, Theory and Evidence,” Open Economies Review, 18(2), pp. 191–214. - Choi, Woo Jin, and Alan M. 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