## 2.1    A primer on the intertemporal savings-investment framework

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### Intertemporal framework and Metzler diagram
- Two-region world with integrated capital markets; savings increase with the real interest rate and investment decreases with the real interest rate.
- Regions are “large” and can affect the world interest rate (r∗). In autarky region A has a higher autarky rate (rA) and region B a lower autarky rate (rB).
- Under financial integration, r∗ lies between rA and rB and equates region A’s desired borrowing (CA_A < 0) with region B’s desired lending (CA_B > 0).
- Key insight: policy shocks affect the current account through their impact on forward-looking savings and investment decisions; persistence and directionality of shocks matter.
- Example: a housing crash in region B that raises uncertainty increases precautionary saving and reduces desired investment, lowering world interest rates and widening CA_B surplus and CA_A deficit.

### Ingredients of the quantitative model
- Quarterly two-country New Keynesian model with traded and nontraded goods.
- Frictions included: nominal rigidities, adjustment costs on investment, hand-to-mouth credit constrained households.
- Model use: complements the Metzler diagram to simulate policies and shocks and to quantify effects on current accounts and macro variables.

### Key mechanics and conceptual findings on industrial policy and tariffs
- Policy effects on current account operate via shifts in desired saving and desired investment schedules and via fiscal financing effects.
- Persistence of shocks matters: temporary versus durable (permanent) shocks produce qualitatively different current account responses.
- Aggregation and sectoral spillovers matter: sectoral (micro) policies may or may not scale into aggregate external balance effects depending on size and network spillovers.

### 3.1 Industrial policy and the current account — Targeted (micro) industrial policy
- Definition and instruments:
  - “Micro” policies favor industries/firms (infant-industry protection, production/export subsidies, directed/subsidized credit, preferential input prices).
  - Often reallocate resources across sectors and shape comparative advantage without clear aggregate CA effects.
- When micro policies can affect aggregate external balances:
  - If targeted sector is sufficiently large (e.g., tradeable sector as a whole) or has significant spillovers via input-output networks.
- Two main channels for aggregate CA effects:
  1. Impact on aggregate productivity (gains if correcting market failures; losses via misallocation).
  2. Fiscal repercussions of subsidies.
- Empirical evidence:
  - Measurement difficulties prevent conclusive empirical assessment.
  - Reduced-form studies: subsidies/industrial policies expand exports and reduce imports in targeted products in China and other emerging economies, albeit not durably.
  - Quantitative analyses indicate important reallocation effects, yielding ambiguity on aggregate impact.

#### Productivity-induced effects: conceptual predictions
- Temporary positive productivity (agents expect short-lived gains):
  - Savings schedule shifts outward (households smooth increased current income).
  - Real interest rate falls (r∗ ↓).
  - Country A borrows more; CA_B widens (CA′_B > CA_B).
- Durable/permanent productivity increase:
  - Investment schedule shifts outward; desired savings fall (higher future income).
  - Autarky and world interest rates increase (r∗ ↑).
  - Country A’s deficit and country B’s surplus decrease (CA′_B < CA_B).
- If industrial policy lowers aggregate productivity (misallocation) and effects are durable, surplus in B would initially increase.
- Conceptual conclusion: industrial policies increase current account surpluses if unsuccessful (temporary productivity gains or durable misallocation that lowers productivity).

#### Model-based confirmation and nuances
- Temporary positive TFP shock to tradable sector:
  - Model supports initial rise in current account driven by higher saving.
  - Numerical specification examples: One percent temporary shock with autoregressive coefficient of 0.9; and one percent permanent shock.
- Sectoral interactions matter:
  - If policy boosts tradables but lowers nontradable productivity, durable fall in nontradable productivity raises relative nontradable prices, appreciates the real exchange rate, reduces competitiveness, and decreases the current account.
- Broad-based subsidies and strategic targets:
  - Example permanent subsidy to investment in tradable sector: subsidy reduces the price of investment in the tradable sector by an amount equal to 0.5% of output each period.
  - Financing options modeled:
    - Tax-financed: ad valorem taxes on consumption raised to make subsidy deficit neutral.
    - Deficit-financed: lump-sum taxes of just 1% of the outstanding stock of debt are raised each period (ensuring subsidy largely financed with debt in the simulation period while ensuring long-run debt stability).
  - Findings:
    - Permanent investment subsidy raises expected future income → households initially dissave and subsidized investment expands → CA falls.
    - If subsidy is financed by higher taxes, initial dissaving is limited; CA deteriorates less when subsidy is financed through immediate taxation than via deficits.
  - Strategic non-financial targets modeled as a permanent fall in tradable sector firms’ desired markup:
    - Investment rises, nontradable input shortages raise nontradable prices, strong RER appreciation reduces competitiveness, net effect: current account balance falls.
- Aggregate conclusion on durable industrial policies:
  - Durable industrial policies are unlikely to increase the current account balance.
  - If successful, they raise domestic investment and consumption in anticipation of income gains → CA falls.
  - If unsuccessful, they reduce competitiveness and drive higher investment to offset lower TFP → CA falls.
  - Exception: CA may rise if policy harms productivity in the targeted export sector or only temporarily increases productivity.

### 3.2 Macroeconomic industrial policy: Financial repression, forced saving, capital controls, and reserves
- Financial repression objective: lower domestic cost of capital relative to global interest rates to support industry/export sectors.
  - Mechanisms: limit deposit interest rates and availability of financial assets, limit lending rates to businesses.
  - On its own, financial repression shifts households further down their desired saving curve (limit saving) and increases desired investment.
- Forced saving measures and examples:
  - Prohibitions on dividend payments to increase retained earnings.
  - Reserve requirements on export earnings.
  - Mandatory saving requirements in pensions or similar products.
  - Weak social safety nets that require high private saving for insurance purposes.
- Capital controls and interest rate wedge:
  - Restrictions on capital outflows create a wedge Δ = rA′ − rB′ > 0 between domestic and abroad interest rates because agents in region B face barriers to trade foreign assets.
  - This wedge allows a larger domestic interest rate decline and boosts investment.

#### Effects of financial repression and forced saving
- Conceptual result: forced saving shifts the domestic savings schedule outward and, when combined with capital controls, can create an interest rate wedge ∆r between the interest rates in region A and region B.
- Knife-edge case:
  - Combination of forced savings and capital controls in region B can leave the world interest rate r∗ unchanged (prevailing in region A) and leave CA balances unaffected in both regions.
- Counterfactual without capital controls:
  - Forced saving in country B would unambiguously increase the current account balance as global capital markets provide a release valve for higher domestic saving; outcome includes more modest increase in domestic investment and a decline in the world interest rate (analogy to the “saving glut”).
- Model-based simulation insights:
  - Forced saving modeled as a highly persistent shock to intertemporal preferences lowering consumption relative to income.
  - With no capital flow management (CFM): forced saving initially raises CAB(%GDP), raises Saving(%GDP), lowers InterestRates (Home and International bond), and leads to RER depreciation.
  - With strict CFM (high adjustment costs to holding the international bond): forced saving has no effect on the current account because private sector faces prohibitive costs to accumulate foreign assets; real exchange rate appreciates due to import compression from lower consumption.
- Policy trade-offs:
  - Forced saving raises national saving but suppresses consumption.
  - When combined with capital controls that “bottle-up” savings domestically and lower domestic interest rates below global rates, accumulation of foreign assets is limited and improvement in the current account is curtailed.

#### Capital account policies and foreign reserve accumulation
- Accounting identity: current account must equal capital account; manipulating the capital account generates a current account of the same size, requiring a real exchange rate depreciation for the rest of the world to absorb the surplus.
- Authorities can accumulate foreign reserves to generate the required depreciation, but some imperfect capital mobility is needed so households cannot offset reserve accumulation by selling foreign assets as the domestic currency depreciates.
- Limit case (closed capital account): reserve accumulation path determines current account balance.
  - To finance reserve accumulation, authorities must raise taxes or issue domestic bonds; national savings must rise.
- Interest rate dynamics with inflow restrictions:
  - Controls on capital inflows can increase the domestic interest rate rB′ while interest abroad falls, creating a wedge ∆ = rA′ − rB′ < 0.
  - In region B, current account surplus increases but higher interest rates depress investment.
  - In region A, lower interest rates push down savings and widen the current account deficit.
- Empirical support: cross-country regressions find current account balance is higher in countries with larger increases in reserves and more restrictive capital controls.
- Model simulation example:
  - Simulated as a highly persistent (but declining) increase in international bond purchases by the government, initially amounting to 1 percent of GDP.
  - Adjustment costs for household transactions of the international bond proxy for capital flow management measures.
  - Outcomes: CAB(%GDP) increases, Saving(%GDP) increases, Inv.(%GDP) declines, InterestRates diverge between Home and Intlbond, and RER appreciates.

#### Combining macro (forced saving / reserve accumulation) and micro-industrial policy
- Micro-industrial policies that increase tradable sector output alone do not necessarily improve the current account:
  - Income effects raise consumption and imports.
  - Nontradable sector imbalance and higher relative nontradable prices appreciate the real exchange rate, offsetting competitiveness gains and potentially causing overheating.
- Combining micro-IP with macro-IP (forced saving) can contain side effects:
  - Forced saving suppresses consumption, preventing rapid rise in nontradable prices and real exchange rate appreciation.
  - With sufficient consumption repression, RER appreciation can be fully reversed, the relative nontradable price increase subdued, and the current account balance effect can turn from negative to positive.
  - Example simulation: permanent fall in desired markup for tradable sector firms; “with additional forced saving” scenario adds an intertemporal preference shock lowering consumption.
- Policy trade-offs and costs:
  - Financial repression/forced saving: suppression of consumption.
  - Reserve accumulation with capital controls: higher domestic interest rates and lower investment.
  - Combined policies can improve output, competitiveness, and the current account, but internal balance is restored through suppressed consumption.

### 3.3 Tariffs and the current account
- Intuition: raising the price of imported products should discourage imports and, everything else equal, improve the trade and current account balance.
- Intertemporal nuance: the rise in import prices increases national saving relative to investment only under certain circumstances.
- Lerner symmetry implication: if the current account is unchanged, the currency of the tariffing country must appreciate enough to offset the impact of tariffs on relative prices and the trade balance.
- The effect of tariffs depends critically on whether trade deficits are temporary or persistent.

#### Models without investment
- Temporary tariffs:
  - Households face a higher consumption-based real interest rate because consumption today is more expensive than tomorrow, so households increase saving and postpone consumption, improving the current account.
- Permanent tariffs:
  - For a country without an initial trade deficit, permanent tariffs generate no intertemporal trade-off and leave the current account unchanged.
  - For a country with an initial trade deficit that is temporary, permanent tariffs still reduce current account balances because consumption composition varies over time and raises the consumption-based real interest rate.
- When countries run permanent trade deficits and hold large cross-border positions, tariffs may have a smaller or counterintuitive effect.

#### Models with investment
- Higher costs of imported goods can lower marginal return to capital if intermediate goods are imported or if currency appreciation reduces demand for exports.
- Without a corresponding fall in desired saving, investment declines and the current account initially improves.
- Unilateral tariffs can lower desired saving if terms of trade improve and tariff revenues are redistributed to households, increasing purchasing power and lowering saving rates relative to GDP.
- Graphical intuition: both savings and investment schedules can shift inward after a permanent across-the-board tariff; if the fall in investment dominates the fall in savings, the deficit in the tariffing region decreases and the world interest rate falls.

#### Model simulations and empirical evidence
- Empirical literature tends to find economically small effects of tariff shocks on trade and current account balances.
- Simulation specifics:
  - Simulated unilateral 10% increase in tariffs on imports.
  - Temporary case specification: half life of 10 quarters.
  - Two fiscal treatments of tariff revenue modeled:
    1. Tariff revenues immediately distributed to households:
       - Temporary unilateral tariff generates a large increase in savings that offsets the decline in investment, generating a current account surplus.
       - Permanent tariff: current account slightly higher initially as investment declines, but as savings decline (reflecting terms-of-trade improvement and transfers), the current account becomes neutral.
    2. Tariff revenues used to lower debt (fiscal consolidation):
       - Non-Ricardian households do not fully offset the increase in government saving by reducing their own saving; overall saving is higher, leading to a persistent increase in the current account.
       - Interest rates are lower under fiscal consolidation, leaving investment slightly higher.
       - Any improvement in the current account comes at the cost of a fall in output.
- Key quantitative points highlighted:
  - Simulated unilateral tariff: 10% increase in tariffs on imports.
  - Temporary tariff specification: half life of 10 quarters.
  - China context: in 2025, fixed investment and private consumption were about 8 percent below their predicted paths in the October 2021 IMF World Economic Outlook.
  - China household saving rate: remains about 2 percentage points above its pre-COVID level.
  - United States general government deficit: now about 2 percent of GDP higher than in 2017.
- Policy implications and conclusions:
  - Tariffs are a limited tool for reducing current account deficits:
    - Permanent tariffs typically fail to alter intertemporal savings decisions; real exchange rate appreciation tends to leave the external balance largely unchanged.
    - Temporary tariffs are more likely to increase the current account by incentivizing saving.
    - Fiscal treatment of tariff revenue is critical:
      - If proceeds are used for fiscal consolidation (pay down government debt), tariffs can narrow external deficits.
      - If proceeds are redistributed to households, the effect on the current account dissipates as household saving falls.
  - Broader conclusion:
    - Micro industrial policies and tariffs have ambiguous effects on current account balances unless temporary or combined with macro policies that depress consumption.
    - Macro industrial policies (forced saving, currency undervaluation) unambiguously boost the current account but suppress consumption.
    - Domestic developments—China’s real estate downturn and rising U.S. fiscal deficits and falling household saving—are plausible drivers of at least part of the recent widening in balances; industrial policy is unlikely to be the sole driver.

*Source: IMF working paper chapter "2.1    A primer on the intertemporal savings-investment framework" (content unit from provided PDF).*

### 2.1    A primer on the intertemporal savings-investment framework

### 2.1    A primer on the intertemporal savings-investment framework

### Intertemporal framework and Metzler diagram
- Two-region world with integrated capital markets; savings increase with the real interest rate and investment decreases with the real interest rate.
- Regions are “large” and can affect the world interest rate (r∗). In autarky region A has a higher autarky rate (rA) and region B a lower autarky rate (rB).
- Under financial integration, r∗ lies between rA and rB and equates region A’s desired borrowing (CA_A < 0) with region B’s desired lending (CA_B > 0).
- Key insight: policy shocks affect the current account through their impact on forward-looking savings and investment decisions; persistence and directionality of shocks matter.
- Example: a housing crash in region B that raises uncertainty increases precautionary saving and reduces desired investment, lowering world interest rates and widening CA_B surplus and CA_A deficit.

### 2.2    Ingredients of the quantitative model

### Model features
- Quarterly two-country New Keynesian model with traded and nontraded goods.
- Frictions included: nominal rigidities, adjustment costs on investment, hand-to-mouth credit constrained households.
- Online Appendix contains detailed derivation (note: not reproduced here).

### Use of the model
- Complements the Metzler diagram to simulate policies and shocks and to quantify effects on current accounts and macro variables.

### 3    Effects of industrial policy and tariffs on the current account

### Overview
- Industrial policy effects separated into:
  - Traditional sector-level (micro) industrial policy.
  - Broader economy-wide adjustment (financial repression, exchange rate interventions).
- Tariffs discussed later (text references literature but not detailed here).

### 3.1    Industrial policy and current account

#### 3.1.1    Targeted Support: The Limited Reach of Sectoral (micro) Industrial Policy

- Definition and instruments:
  - “Micro” policies favor industries/firms (infant-industry protection, production/export subsidies, directed/subsidized credit, preferential input prices).
  - Often reallocate resources across sectors and shape comparative advantage without clear aggregate CA effects.
- When micro policies can affect aggregate external balances:
  - If targeted sector is sufficiently large (e.g., tradeable sector as a whole) or has significant spillovers via input-output networks.
- Two main channels for aggregate CA effects:
  1. Impact on aggregate productivity (gains if correcting market failures; losses via misallocation).
  2. Fiscal repercussions of subsidies.
- Empirical evidence:
  - Difficulties in measuring industrial policies consistently across countries/time prevent conclusive empirical assessment of effects on the current account.
  - Reduced-form studies: subsidies/industrial policies expand exports and reduce imports in targeted products in China and other emerging economies, albeit not durably.
  - Quantitative analyses indicate important reallocation effects, yielding ambiguity on aggregate impact.

##### Productivity-induced effects: conceptual predictions
- If surplus country B implements micro industrial policy via deficit-neutral targeted fiscal instruments:
  - Positive productivity effects can be temporary or durable; effects on CA differ.
  - Temporary positive productivity (agents expect short-lived gains):
    - Savings schedule shifts outward (households smooth increased current income).
    - Real interest rate falls (r∗ ↓).
    - Country A borrows more; CA_B widens (CA′_B > CA_B).
  - Durable/permanent productivity increase:
    - Investment schedule shifts outward; desired savings fall (higher future income).
    - Autarky and world interest rates increase (r∗ ↑).
    - Country A’s deficit and country B’s surplus decrease (CA′_B < CA_B).
  - If industrial policy lowers aggregate productivity (misallocation) and effects are durable, surplus in B would initially increase (per model discussion).
- Conceptual conclusion: industrial policies increase current account surpluses if unsuccessful (temporary productivity gains or durable misallocation that lowers productivity).

##### Model-based confirmation and nuances
- Temporary positive TFP shock to tradable sector:
  - Model supports initial rise in current account driven by higher saving.
  - Numerical specification: One percent temporary shock with autoregressive coefficient of 0.9; and one percent permanent shock (see Figure 5 note).
  - Figures show CAB(%GDP), Saving(%GDP), Inv.(%GDP) responses over Quarters 10–40 for Temporary and Permanent cases.
- Sectoral interactions matter:
  - If policy boosts tradables but lowers nontradable productivity (misallocation), outcome differs:
    - Durable fall in nontradable productivity creates scarcity, raises relative nontradable prices, appreciates the real exchange rate, reduces competitiveness, and decreases the current account (see Figure 6 note).
  - Figure 6 numerical setup: One percent permanent positive shock to TFP in the tradable sector and one percent permanent negative shock to TFP in the nontradable sector. Responses shown over Quarters 5–20 for CAB(%GDP), Inv.(%GDP), Saving(%GDP), Relativenontradableprice, and RER(-isappreciation).

#### 3.1.2    Targeted Support: Broad-based subsidies and strategic targets

- Permanent subsidy to investment in the tradable sector (example quantitative experiment):
  - Subsidy reduces the price of investment in the tradable sector by an amount equal to 0.5% of output each period (per Figure 7 note).
  - Financing matters:
    - Tax-financed: ad valorem taxes on consumption raised to make subsidy deficit neutral.
    - Deficit-financed: lump-sum taxes of just 1% of the outstanding stock of debt are raised each period (ensuring subsidy largely financed with debt in the simulation period while ensuring long-run debt stability).
  - Responses displayed over Quarters 10–40 for CAB(%GDP), Saving(%GDP), Inv.(%GDP); labels show De-ficit-nanced and Tax-nanced series.
- Findings on financing:
  - Permanent investment subsidy raises expected future income → households initially dissave and subsidized investment expands → CA falls.
  - If subsidy is financed by higher taxes, the initial dissaving is limited because disposable income is lower; effect is strongest when fiscal burden falls on credit constrained households.
  - Result: CA deteriorates less when subsidy is financed through immediate taxation than via deficits.
- Strategic targets to boost tradable sector output without financial incentives (state directives to raise output at the expense of margins):
  - Modeled as a permanent fall in tradable sector firms’ desired markup, reducing profit margins while increasing output (Figure 8 note).
  - Dynamics:
    - Investment rises as firms target higher output at lower margins.
    - Relative shortage of inputs in the nontradable sector increases demand for workers and investment, raising nontradable prices.
    - Sharp appreciation of the real exchange rate reduces competitiveness and can reverse any direct export expansion from higher tradable output.
    - Net effect: current account balance falls.
- Aggregate conclusion on durable industrial policies:
  - Durable industrial policies are unlikely to increase the current account balance.
  - If successful (boost productivity or investment in export sector), they raise domestic investment and consumption in anticipation of income gains → CA falls.
  - If unsuccessful (generate misallocation harming nontradables), they reduce competitiveness and drive higher investment to offset lower TFP → CA falls.
  - Exception: CA may rise if policy harms productivity in the targeted export sector or only temporarily increases productivity.

### 3.2    Macroeconomic industrial policy: Broader reach, more bite

#### 3.2.1    Financial repression and forced saving
- Macroeconomic/financial policies sometimes accompany targeted industrial policies to promote industrial development and exports at scale by lowering borrowing costs or managing the exchange rate.
- Financial repression objective: lower domestic cost of capital relative to global interest rates to support industry/export sectors.
  - Mechanisms: limit deposit interest rates and availability of financial assets, limit lending rates to businesses.
  - On its own, financial repression shifts households further down their desired saving curve (limit saving) and increases desired investment.
- In practice, financial repression is often combined with forced saving policies that shift desired saving curve to the right, examples include:
  - Prohibitions on dividend payments to increase retained earnings.
  - Reserve requirements on export earnings.
  - Mandatory saving requirements in pensions or similar products.
  - Weak social safety nets that require high private saving for insurance purposes.
- Empirical evidence:
  - Measurement challenges exist; Abiad, Detragiache and Tressel (2008) constructed an index covering seven repression policies until 2005; extension to 2017 covers only interest rate controls component.
  - Johansson and Wang (2012) find a positive association between current account balance and financial repression across countries using the index.
- Capital controls and interest rate wedge:
  - Policies often include restrictions on capital outflows, creating a wedge Δ = rA′ − rB′ > 0 between domestic and abroad interest rates because agents in region B face barriers to trade foreign assets.
  - This wedge allows a larger domestic interest rate decline and boosts investment (text ends mid-sentence in provided excerpt).

*Source: IMF working paper chapter "2.1    A primer on the intertemporal savings-investment framework" (content unit from provided PDF).*

### introduction of forced saving measures.

### introduction of forced saving measures

### Effects of financial repression and capital flow measures
- Conceptual result: Financial repression (forced saving) shifts the domestic savings schedule outward and, when combined with capital controls, can create an interest rate wedge between regions: the capital controls create a wedge ∆r between the interest rates in region A and region B.
- Knife-edge case depicted in Figure 9:
  - Combination of forced savings and capital controls in region B can leave the world interest rate r∗ unchanged (prevailing in region A).
  - Current account balances (CA) remain unaffected in both regions in this knife-edge case.
- Counterfactual without capital controls:
  - Forced saving policies in country B would unambiguously increase the current account balance as global capital markets provide a release valve for higher domestic saving.
  - The outcome is a more modest increase in domestic investment and a decline in the world interest rate (analogy to the “saving glut” of the 2000s).
- Model-based simulation insights (Figure 10):
  - Forced saving modeled as a highly persistent shock to intertemporal preferences lowering consumption relative to income.
  - With no capital flow management (CFM), forced saving initially raises the current account balance (CAB(%GDP)), raises Saving(%GDP), lowers InterestRates (Home and International bond), and leads to RER depreciation.
  - With strict CFM (high adjustment costs to holding the international bond), forced saving has no effect on the current account because private sector faces prohibitive costs to accumulate foreign assets; real exchange rate appreciates due to import compression from lower consumption.
- Policy trade-offs:
  - Forced saving raises national saving but suppresses consumption.
  - When combined with capital controls that “bottle-up” savings domestically and lower domestic interest rates below global rates, accumulation of foreign assets is limited and improvement in the current account is curtailed.

### Capital account policies and foreign reserve accumulation
- Accounting identity: current account must equal capital account; manipulating the capital account generates a current account of the same size, requiring a real exchange rate depreciation for the rest of the world to absorb the surplus.
- Mechanism: Authorities can accumulate foreign reserves to generate the required depreciation, but some imperfect capital mobility is needed so households cannot offset reserve accumulation by selling foreign assets as the domestic currency depreciates.
- Limit case (closed capital account): Reserve accumulation path determines current account balance (Jeanne, 2013).
  - To finance reserve accumulation, authorities must raise taxes or issue domestic bonds; national savings must rise.
- Interest rate dynamics with inflow restrictions:
  - Controls on capital inflows can increase the domestic interest rate rB′ while interest abroad falls, creating a wedge ∆ = rA′ − rB′ < 0.
  - In region B, current account surplus increases but higher interest rates depress investment.
  - In region A, lower interest rates push down savings and widen the current account deficit.
- Empirical support:
  - Cross-country regressions find current account balance is higher in countries with larger increases in reserves and more restrictive capital controls.
- Model-based simulation (Figure 12):
  - Simulated as a highly persistent (but declining) increase in international bond purchases by the government, initially amounting to 1 percent of GDP.
  - Adjustment costs for household transactions of the international bond proxy for capital flow management measures.
  - Outcomes: CAB(%GDP) increases, Saving(%GDP) increases, Inv.(%GDP) declines, InterestRates show divergence between Home and Intlbond, and RER shows appreciation (RER(-isappreciation) scale).

### Combining macro (forced saving / reserve accumulation) and micro-industrial policy
- Micro-industrial policies that increase tradable sector output alone do not necessarily improve the current account:
  - Income effects raise consumption and imports.
  - Nontradable sector imbalance and higher relative nontradable prices appreciate the real exchange rate, offsetting competitiveness gains.
  - Successful micro-IP can exacerbate internal imbalance and lead to overheating (Obstfeld, 2026).
- Combining micro-IP with macro-IP (forced saving) can contain side effects:
  - Forced saving suppresses consumption, preventing rapid rise in nontradable prices and real exchange rate appreciation.
  - With sufficient consumption repression, RER appreciation can be fully reversed, the relative nontradable price increase subdued, and the current account balance effect can turn from negative to positive (Figure 13).
  - Simulated as a permanent fall in desired markup for tradable sector firms; the “with additional forced saving” scenario adds an intertemporal preference shock lowering consumption.
- Policy trade-offs and costs:
  - Financial repression/forced saving: suppression of consumption.
  - Reserve accumulation with capital controls: higher domestic interest rates and lower investment.
  - Combined policies can improve output, competitiveness, and the current account, but internal balance is restored through suppressed consumption.

*Source: wpiea2026067-source-pdf - introduction of forced saving measures*

### 3.3    Tariffs and the current account

### 3.3    Tariffs and the current account

### Mechanics and theoretical insights
- Intuition: raising the price of imported products should discourage imports and, everything else equal, improve the trade and current account balance.
- Intertemporal framework nuance: the rise in import prices increases national saving relative to investment only under certain circumstances.
- Lerner symmetry (Razin and Svensson, 1983) implication: if the current account is unchanged, the currency of the tariffing country must appreciate enough to offset the impact of tariffs on relative prices and the trade balance.
- The effect of tariffs depends critically on whether trade deficits are temporary (expected to be offset by future surpluses) or persistent (offset by net foreign assets or excess returns).

### Models without investment
- Temporary tariffs:
  - Domestic households face a higher consumption-based real interest rate because consumption today is more expensive than tomorrow.
  - Households increase saving and postpone consumption, improving the current account.
- Permanent tariffs:
  - For a country without an initial trade deficit, permanent tariffs generate no intertemporal trade-off and leave the current account unchanged.
  - For a country with an initial trade deficit that is temporary, permanent tariffs still reduce current account balances because consumption composition varies over time and raises the consumption-based real interest rate.
- When countries run permanent trade deficits and hold large cross-border positions, tariffs may have a smaller or even counterintuitive effect on trade deficits; the overall effect is dictated by the structure of gross financial positions and changes in market value of net foreign assets and associated excess returns.

### Models with investment
- Adding investment makes the impact on the current account more complex:
  - Higher costs of imported goods can lower the marginal return to capital if intermediate goods are imported or if currency appreciation reduces demand for exports.
  - Without a corresponding fall in desired saving, investment declines and the current account initially improves.
  - Unilateral tariffs can also lower desired saving if terms of trade improve and tariff revenues are redistributed to households, increasing real purchasing power and lowering saving rates relative to GDP.
- Graphical intuition (Figure 14 summary):
  - Both savings and investment schedules can shift inward after a permanent across-the-board tariff.
  - If the fall in investment dominates the fall in savings, the deficit in the tariffing region (Region A) decreases; the world interest rate falls, reducing surpluses in Region B.

### Model simulations and empirical evidence
- Empirical literature:
  - Tends to find economically small effects of tariff shocks on trade and current account balances (e.g., Boer and Rieth, 2024; Furceri et al., 2022).
  - Schmitt-Grohé and Uribe (2025) using historical U.S. data: transitory tariff shocks increase the current account, while permanent changes have muted effects.
  - Quantitative long-run GE trade models (Caliendo, Kortum and Parro, 2025; Ignatenko et al., 2025) find U.S. current account deficit and welfare decrease under scenarios based on U.S. tariff increases during 2025.
- Model simulation results (summarized from Figure 15):
  - Simulated unilateral 10% increase in tariffs on imports with all tariff revenues immediately distributed to households (top row).
    - Temporary case: tariffs have a half life of 10 quarters.
    - Temporary unilateral tariff generates a large increase in savings that offsets the decline in investment, generating a current account surplus.
    - Permanent tariff: current account slightly higher initially as investment declines, but as savings decline (reflecting terms-of-trade improvement and transfers), the current account becomes neutral.
  - Simulated unilateral 10% increase in tariffs with proceeds used to lower debt (bottom row).
    - When tariff revenues are used to pay down government debt (fiscal consolidation), households (non-Ricardian in the model) do not fully offset the increase in government saving by reducing their own saving.
    - Overall saving is higher, leading to a persistent increase in the current account.
    - Interest rates are lower under fiscal consolidation, leaving investment slightly higher.
    - Any improvement in the current account comes at the cost of a fall in output.

### Key quantitative points from broader context
- Simulated unilateral tariff: 10% increase in tariffs on imports.
- Temporary tariff specification: half life of 10 quarters.
- China: in 2025, fixed investment and private consumption were about 8 percent below their predicted paths in the October 2021 IMF World Economic Outlook.
- China household saving rate: remains about 2 percentage points above its pre-COVID level.
- United States general government deficit: now about 2 percent of GDP higher than in 2017.

### Policy implications and conclusions
- Tariffs are a limited tool for reducing current account deficits:
  - Permanent tariffs typically fail to alter intertemporal savings decisions; instead, a real exchange rate appreciation tends to leave the external balance largely unchanged.
  - Temporary tariffs are more likely to increase the current account by incentivizing saving.
  - The fiscal treatment of tariff revenue is critical:
    - If proceeds are used for fiscal consolidation (pay down government debt), tariffs can narrow external deficits.
    - If proceeds are redistributed to households, the effect on the current account dissipates as household saving falls.
- Broader conclusion regarding drivers of recent widening global imbalances:
  - Micro industrial policies and tariffs have ambiguous effects on current account balances unless temporary or combined with macro policies that depress consumption.
  - Macro industrial policies (forced saving, currency undervaluation) unambiguously boost the current account but suppress consumption.
  - Domestic developments—China’s real estate downturn and rising U.S. fiscal deficits and falling household saving—are plausible drivers of at least part of the recent widening in balances; industrial policy is unlikely to be the sole driver.

*Source: 3.3    Tariffs and the current account (wpiea2026067-source-pdf)*

### References

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- Evenett, Simon, Adam Jakubik, Fernando Martín, and Michele Ruta. 2024. “The return of industrial policy in data.” The World Economy, 47(7): 2762–2788.
- Evenett, Simon, Adam Jakubik, Jaden Jonghyuk Kim, Fernando Martín, Samuel Pienknagura, Michele Ruta, Sandra Baquie, Yueling Huang, and Rafael Machado Parente. 2025. “Industrial Policy Since the Great Financial Crisis.” International Monetary Fund, IMF Working Paper 2025/222.
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### Recent and forthcoming studies on industrial policy, tariffs, and global imbalances
- Bartelme, Dominick, Arnaud Costinot, Dave Donaldson, and Andres Rodriguez-Clare. 2025. “The textbook case for industrial policy: Theory meets data.” Journal of Political Economy, 133(5): 1527–1573.
- Barwick, Panle Jia, Hyuk-Soo Kwon, Shanjun Li, and Nahim B Zahur. 2025. “Drive down the cost: Learning by doing and government policies in the global EV battery industry.” National Bureau of Economic Research, Working paper 33378.
- Bayas-Erazo, Matias, and Guido Lorenzoni. 2025. “Tariffs and current account deficits.” mimeo.
- Caliendo, Lorenzo, Samuel S Kortum, and Fernando Parro. 2025. “Tariffs and trade deficits.” National Bureau of Economic Research, NBER Working paper 34003.
- Cesa-Bianchi, Ambrogio, Andrea Ferrero, Luca Fornaro, and Martin Wolf. 2026. “Industrial Policies, Global Imbalances, and Technological Hegemony.”
- Choi, Jaedo, and Andrei A Levchenko. 2025. “The long-term effects of industrial policy.” Journal of Monetary Economics, 152: 103779.
- Costinot, Arnaud, and Ivan Werning. 2025. “How tariffs affect trade deficits.” National Bureau of Economic Research, NBER Working Paper 33709.
- Evenett, Simon, et al. 2025. “Industrial Policy Since the Great Financial Crisis.” International Monetary Fund, IMF Working Paper 2025/222.
- Garcia-Macia, Daniel, Siddharth Kothari, and Yifan Tao. 2025. “Industrial policy in china: Quantification and impact on misallocation.” International Monetary Fund, IMF Working Papers 2025/155.
- Huang, Yueling, et al. 2025. “Do Industrial Policies Increase Trade Competitiveness?” International Monetary Fund, IMF Working Paper 2025/98.
- Itskhoki, Oleg, and Dmitry Mukhin. 2025a. “Can a tariff be used to close a long-run trade deficit?” mimeo.
- Itskhoki, Oleg, and Dmitry Mukhin. 2025b. “Global Imbalances: A Progress Report.” mimeo.
- Itskhoki, Oleg, and Dmitry Mukhin. 2025c. “The optimal macro tariff.” National Bureau of Economic Research, NBER Working Paper 33839.
- Ju, Jiandong, Yuankun Li, and Shang-Jin Wei. 2026. “The United States as an Active Industrial Policy Nation.” National Bureau of Economic Research, NBER Working Paper 34744.
- Lane, Nathan. 2025. “Manufacturing revolutions: Industrial policy and industrialization in South Korea.” The Quarterly Journal of Economics, 1683–1741.
- Rotunno, Lorenzo, and Michele Ruta. 2024a/2024b. “Trade Implications of China’s Subsidies.” International Monetary Fund, IMF Working Paper 2024/180; “Trade Spillovers of Domestic Subsidies.” International Monetary Fund, IMF Working Paper 2024/180.

*Global Imbalances, Industrial Policy and Tariffs — Working Paper No. WP/2026/067*

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_Source: https://www.imf.org/-/media/files/publications/wp/2026/english/wpiea2026067-source-pdf.pdf_