## _sdn1103 - Executive Summary

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---

### Introduction
- Purpose: discuss two issues: (1) why a country might want to reduce its current account deficit or surplus; and (2) why the international community might ask for more.
- Motivation: informed design of “rules of the game” and to contribute to G-20 request to the IMF for “indicative guidelines” for reduction of global current account imbalances.
- Organization: succinct treatment of domestic reasons (Section II), multilateral considerations (Section III), and implications for rules of the game (Section IV).

### Domestic reasons to reduce current account deficits or surpluses
- General point: current account balances often reflect underlying domestic distortions; removing those distortions typically reduces imbalances and benefits the country.
- Current account deficits:
  - Can arise for “bad” reasons: financial regulation failures fueling credit booms; fiscal misbehavior reducing national saving. Correcting these distortions is generally desirable and will reduce the deficit.
  - Can arise for “good” reasons: temporarily low export prices; bright future prospects leading to low saving; high marginal product of capital raising investment.
  - Even “good” deficits warrant concern because they can interact with distortions (e.g., dynamic Dutch disease) or be vulnerable to changes in foreign lenders’ sentiment, triggering sudden stops and painful adjustments.
- Current account surpluses:
  - Can arise for “bad” reasons: lack of social insurance (raising private saving); inefficient financial intermediation (reducing investment); other distortions that often show up as a more depreciated real exchange rate. Removing these distortions is typically desirable.
  - Can arise for “good” reasons: aging populations saving for retirement; limited domestic investment opportunities; positive productivity externalities from a strong tradable sector and an export-led growth strategy.
  - Key distinction: individual surpluses are generally more sustainable than deficits because they do not depend on foreign financing of domestic consumption and investment and tend to unwind gradually as foreign asset accumulation increases domestic demand.

### Multilateral considerations for reducing imbalances
- Overview: three distinct arguments justify multilateral concern—one supports restrictions on deficits, two support restrictions on surpluses.

- A. Current account deficits, sudden stops, and spillover effects
  - Large deficits increase the risk of sudden stops and large financial disruptions; poor cross-border resolution amplifies spillovers through complex financial linkages.
  - Implication: surveillance (and possibly restrictions) should focus beyond the current account balance to include gross flows, stocks, the level and composition of foreign assets and liabilities, distribution of external exposures across sectors, and country size.

- B. Export-led growth, current account surpluses, and unfair competition
  - An export-led strategy (depreciated real exchange rate plus low domestic demand) is formally equivalent to tariffs plus export subsidies and may have adverse effects on other countries’ competitiveness.
  - Practical challenge: proving intent (deliberate undervaluation to gain competitive advantage) is difficult; steady reserve accumulation is not definitive proof because capital controls can produce the same observable outcome.
  - Implication: revisiting multilateral tolerance for export-led strategies may be warranted, but implementation and enforcement are likely to be difficult and politically sensitive.

- C. Current account surpluses, the liquidity trap, and world demand
  - In normal times (positive interest rates worldwide), surpluses need not reduce output elsewhere because interest rate and exchange rate adjustments can maintain output at potential across countries.
  - When parts of the world are in a liquidity trap and interest rates cannot fall, large surpluses in some countries can reduce aggregate demand and output in others. Fiscal policy could offset this but may be constrained by debt sustainability concerns.
  - Implication: under liquidity-trap conditions, reducing surpluses via real appreciation and higher domestic demand in surplus countries can raise output in deficit countries, supporting a case for time- and country-specific multilateral guidelines.

### Implications for “rules of the game”
- Two roles for multilateral surveillance:
  - Facilitate discussion of differences in assessments of costs and benefits across countries.
  - Serve as a commitment device to help implement politically difficult fiscal or structural adjustments.
- Key conclusions (verbatim summary of arguments):
  - Worries about cross-border effects of sudden stops justify multilateral surveillance. They also suggest, however, looking beyond the current account deficit, at the whole structure of the capital account.
  - Worries about unfair competitive advantage may justify restrictions on undervaluation and current account surpluses, but implementation is likely to be difficult. Proving intent may be next to impossible. Ignoring intent may be unfair.
  - Worries about global demand if part of the world economy is in a liquidity trap. In that context, smaller current account surpluses in surplus countries might actually benefit growth in the rest of the world. The relevant question is why surplus countries should oblige. One answer is based on a repeated-game argument: a surplus country today may be a deficit country in the future, and thus benefit from such a rule. The argument is not convincing: the world economy is not ergodic, and the likelihood that the roles will be reversed in the future is small. Another, more pragmatic, argument is that in many (but not all) surplus countries domestic and multilateral considerations actually go in the same direction. To the extent that these countries reduce domestic distortions, this will be good for them, and good for the rest of the world. And, even if one could hope for more, this can go a long way toward strengthening the world recovery.

### Appendix — Two-country model: Current account surpluses, the liquidity trap, and world demand
- Model setup:
  - Two-country macroeconomic model. Demand for domestic output Y in the home country is a function of the real exchange rate e (the price of domestic goods in terms of foreign goods) and of the interest rate r. Appreciation reduces demand by crowding out net exports; lower r increases demand. Foreign country has an analogous condition where an appreciation in the home country is associated with higher foreign output.
  - Iso-output properties are presented as sign conditions in the source (symbolic expressions preserved there).
- Iso-output geometry:
  - Home country iso-output loci are downward sloping: for a given level of output, a decrease in r (which increases domestic demand) requires an appreciation (which reduces the current account).
  - Foreign country iso-output loci are upward sloping.
- Policy and equilibrium assumptions:
  - Policy is used to maintain output at potential in both countries.
  - Perfect capital mobility implies domestic and foreign interest rates must be equal (formal equalities and symbolic expressions preserved in the source).
- Scenario 1 — Increase in desired saving in the foreign country (general case):
  - For a given r*, maintaining output at potential requires a depreciation from the point of view of the foreign country, i.e., an increase in e.
  - The foreign iso-output curve shifts right; equilibrium moves from point A to point B.
  - Consequences:
    - Exchange rate is higher.
    - Equilibrium interest rate is lower.
    - Increase in foreign saving drives down the world interest rate.
    - Foreign country: adverse shift in demand is offset by lower r and a depreciation; output remains at potential; current account improves.
    - Home country: appreciation is offset by lower r; output remains at potential; appreciation leads to deterioration of the current account.
- Footnote on risk premium:
  - “It is straightforward to include a risk premium in the model driving a wedge between the domestic and foreign interest rates.” (Footnote 12)
- Scenario 2 — Increase in foreign saving when domestic short-term interest rate is at or close to zero (liquidity trap case):
  - Initial iso-loci drawn so initial equilibrium interest rate equals zero. Foreign iso-locus shifts right; interest rate cannot decrease further. New equilibrium at point C.
  - Consequences:
    - Home country cannot offset the depreciation through a decrease in r; output is lower.
    - The iso-locus through point C corresponds to a lower level of output.
    - Higher desired saving in the foreign country leads to a decrease in output in the home country.
- Policy implication from the appendix:
  - Alternative policy instruments, most obviously fiscal policy, can help sustain domestic demand in the home country.
  - However, fiscal policy may not be viable if there is a need for fiscal policy adjustment to ensure debt sustainability.

*Source: EXECUTIVE SUMMARY of Staff Discussion Note _sdn1103 (pages 4-15).*

### Executive Summary ......................................................................................................

### _sdn1103 - Executive Summary ......................................................................................................

### Executive Summary
- Listed on page 4.

### I. Introduction
- Listed on page 5.

### II. Why Might a Country Want to Reduce Its Current Account Deficit or Surplus
- Listed on page 5.
- Subsections:
  - A. Current Account Deficits: Possibly Unwise, and Unsustainable (page 5)
  - B. Current Account Surpluses: Possibly Unwise, but largely Sustainable (page 6)

### III. Multilateral Considerations
- Listed on page 7.
- Subsections:
  - A. Current Account Deficits, Sudden Stops, and Spillover Effects (page 7)
  - B. Export-Led Growth, Current Account Surpluses, and Unfair Competition (page 8)
  - C. Current Account Surpluses, the Liquidity Trap, and World Demand (page 9)

### IV. Implications for “Rules of the Game”
- Listed on page 10.

### References
- Listed on page 12.

### Appendix and Figures
- Appendix listed on page 13.
- Figure 1 listed on page 14.
- Figure 2 listed on page 15.
- Figure 3 listed on page 15.

*Source: _sdn1103 - Executive Summary (pages 4-15).*

### EXECUTIVE SUMMARY

### _sdn1103 - EXECUTIVE SUMMARY

### Introduction
- Purpose: discuss two issues: (1) why a country might want to reduce its current account deficit or surplus; and (2) why the international community might ask for more.  
- Motivation: informed design of “rules of the game” and to contribute to G-20 request to the IMF for “indicative guidelines” for reduction of global current account imbalances.  
- Organization: succinct treatment of domestic reasons (Section II), multilateral considerations (Section III), and implications for rules of the game (Section IV).

### Domestic reasons to reduce current account deficits or surpluses
- General point: current account balances often reflect underlying domestic distortions; removing those distortions typically reduces imbalances and benefits the country.
- Current account deficits:
  - Can arise for “bad” reasons: financial regulation failures fueling credit booms; fiscal misbehavior reducing national saving. Correcting these distortions is generally desirable and will reduce the deficit.
  - Can arise for “good” reasons: temporarily low export prices; bright future prospects leading to low saving; high marginal product of capital raising investment.
  - Even “good” deficits warrant concern because they can interact with distortions (e.g., dynamic Dutch disease) or be vulnerable to changes in foreign lenders’ sentiment, triggering sudden stops and painful adjustments.
- Current account surpluses:
  - Can arise for “bad” reasons: lack of social insurance (raising private saving); inefficient financial intermediation (reducing investment); other distortions that often show up as a more depreciated real exchange rate. Removing these distortions is typically desirable.
  - Can arise for “good” reasons: aging populations saving for retirement; limited domestic investment opportunities; positive productivity externalities from a strong tradable sector and an export-led growth strategy.
  - Key distinction: individual surpluses are generally more sustainable than deficits because they do not depend on foreign financing of domestic consumption and investment and tend to unwind gradually as foreign asset accumulation increases domestic demand.

### Multilateral considerations for reducing imbalances
- Overview: three distinct arguments justify multilateral concern—one supports restrictions on deficits, two support restrictions on surpluses.
- A. Current account deficits, sudden stops, and spillover effects
  - Large deficits increase the risk of sudden stops and large financial disruptions; poor cross-border resolution amplifies spillovers through complex financial linkages.
  - Implication: surveillance (and possibly restrictions) should focus beyond the current account balance to include gross flows, stocks, the level and composition of foreign assets and liabilities, distribution of external exposures across sectors, and country size.
- B. Export-led growth, current account surpluses, and unfair competition
  - An export-led strategy (depreciated real exchange rate plus low domestic demand) is formally equivalent to tariffs plus export subsidies and may have adverse effects on other countries’ competitiveness.
  - Practical challenge: proving intent (deliberate undervaluation to gain competitive advantage) is difficult; steady reserve accumulation is not definitive proof because capital controls can produce the same observable outcome.
  - Implication: revisiting multilateral tolerance for export-led strategies may be warranted, but implementation and enforcement are likely to be difficult and politically sensitive.
- C. Current account surpluses, the liquidity trap, and world demand
  - In normal times (positive interest rates worldwide), surpluses need not reduce output elsewhere because interest rate and exchange rate adjustments can maintain output at potential across countries.
  - When parts of the world are in a liquidity trap and interest rates cannot fall, large surpluses in some countries can reduce aggregate demand and output in others. Fiscal policy could offset this but may be constrained by debt sustainability concerns.
  - Implication: under liquidity-trap conditions, reducing surpluses via real appreciation and higher domestic demand in surplus countries can raise output in deficit countries, supporting a case for time- and country-specific multilateral guidelines.

### Implications for “rules of the game”
- Two roles for multilateral surveillance:
  - Facilitate discussion of differences in assessments of costs and benefits across countries.
  - Serve as a commitment device to help implement politically difficult fiscal or structural adjustments.
- Key conclusions (verbatim summarizing arguments):
  - Worries about cross-border effects of sudden stops justify multilateral surveillance. They also suggest, however, looking beyond the current account deficit, at the whole structure of the capital account.
  - Worries about unfair competitive advantage may justify restrictions on undervaluation and current account surpluses, but implementation is likely to be difficult. Proving intent may be next to impossible. Ignoring intent may be unfair.
  - Worries about global demand if part of the world economy is in a liquidity trap. In that context, smaller current account surpluses in surplus countries might actually benefit growth in the rest of the world. The relevant question is why surplus countries should oblige. One answer is based on a repeated-game argument: a surplus country today may be a deficit country in the future, and thus benefit from such a rule. The argument is not convincing: the world economy is not ergodic, and the likelihood that the roles will be reversed in the future is small. Another, more pragmatic, argument is that in many (but not all) surplus countries domestic and multilateral considerations actually go in the same direction. To the extent that these countries reduce domestic distortions, this will be good for them, and good for the rest of the world. And, even if one could hope for more, this can go a long way toward strengthening the world recovery.

*Source: EXECUTIVE SUMMARY of Staff Discussion Note _sdn1103*

### References

### References

### Citations
- Bernanke, Ben S., Carol Bertaut, Laurie Pounder deMarco, and Steven Kamin, 2011, “International Capital Flows and the Returns to Safe Assets in the United States, 20003-2007,” Federal Reserve Board International Finance Discussion Paper 1014, February.
- Blanchard, Olivier, Mitali Das, and Hamid Faruqee, 2010, “The Initial Impact of the Crisis on Emerging Market Countries,” Brookings Papers on Economic Activity, spring, pp. 263–307.
- Blanchard, Olivier, and Gian Maria Milesi-Ferretti, 2010), “Global Imbalances: In Midstream?” in Reconstructing the World Economy, edited by Olivier Blanchard and Il SaKong (Washington: International Monetary Fund).
- Caballero, Ricardo, and Guido Lorenzoni, 2007, “Persistent Appreciations and Overshooting: A Normative Analysis,” NBER Working Paper 13077 (Cambridge, MA: National Bureau of Economic Research).
- International Monetary Fund, 2007, “Staff Report on the Multilateral Consultation on Global Imbalances with China, the Euro Area, Japan, Saudi Arabia, and the United States.” Available via the Internet: http://www.imf.org/external/np/pp/2007/eng/062907.pdf.
- Korinek, Anton, 2010, “Regulating Capital Flows to Emerging Markets: An Externality View” (unpublished; College Park: University of Maryland), May.
- Lane, Philip R., and Gian Maria Milesi-Ferretti, 2010, “The Cross-Country Incidence of the Global Crisis,” IMF Working Paper 10/171 (Washington: International Monetary Fund); forthcoming, IMF Economic Review, via the Internet: http://www.palgrave-journals.com/imfer/journal/vaop/ncurrent/full/imfer201012a.html.
- Mateos y Lago, Isabelle, Rupa Duttagupta, and Rishi Goyal, 2009, “The Debate on the International Monetary System,” IMF Staff Position Note 09/26 (Washington: International Monetary Fund).
- Obstfeld, Maurice, and Kenneth Rogoff, 2010, “Global Imbalances and the Financial Crisis: Products of Common Causes,” in Asia Economic Policy Conference Volume, Federal Reserve Bank of San Francisco.

### Appendix — Current Account Surpluses, the Liquidity Trap, and World Demand: A Simple Model

- Model setup:
  - Two-country macroeconomic model.
  - Demand for domestic output Y in the home country is a function of the real exchange rate e (the price of domestic goods in terms of foreign goods) and of the interest rate r.
  - Appreciation reduces demand by crowding out net exports; lower r increases demand.
  - Foreign country has an analogous condition where an appreciation in the home country is associated with higher foreign output.
  - Iso-output properties (symbolic conditions preserved as in source):
    - (, )0,0
    - (,  )0,0
    - r
    - er
    - e
    - YYerYY
    - YYerYY
    - (These expressions appear in the source as the formal sign conditions for derivatives of Y with respect to e and r.)

- Iso-output loci geometry:
  - Home country iso-output loci are downward sloping: for a given level of output, a decrease in r (which increases domestic demand) requires an appreciation (which reduces the current account).
  - Foreign country iso-output loci are upward sloping.

- Policy and equilibrium assumptions:
  - Policy is used to maintain output at potential in both countries.
  - Perfect capital mobility implies domestic and foreign interest rates must be equal:
    - 12
    - **
    - *
    - YY
    - YY
    - rr
    - =
    - =
    - =

- Scenario 1 — Increase in desired saving in the foreign country (general case):
  - For a given r*, maintaining output at potential requires a depreciation from the point of view of the foreign country, i.e., an increase in e.
  - The foreign iso-output curve shifts right; equilibrium moves from point A to point B.
  - Consequences:
    - Exchange rate is higher.
    - Equilibrium interest rate is lower.
    - Increase in foreign saving drives down the world interest rate.
    - Foreign country: adverse shift in demand is offset by lower r and a depreciation; output remains at potential; current account improves.
    - Home country: appreciation is offset by lower r; output remains at potential; appreciation leads to deterioration of the current account.

- Footnote on risk premium:
  - “It is straightforward to include a risk premium in the model driving a wedge between the domestic and foreign interest rates.” (Footnote 12)

- Scenario 2 — Increase in foreign saving when domestic short-term interest rate is at or close to zero (liquidity trap case):
  - Initial iso-loci drawn so initial equilibrium interest rate equals zero.
  - Foreign iso-locus shifts right; interest rate cannot decrease further.
  - New equilibrium at point C.
  - Consequences:
    - Home country cannot offset the depreciation through a decrease in r; output is lower.
    - The iso-locus through point C corresponds to a lower level of output.
    - Higher desired saving in the foreign country leads to a decrease in output in the home country.

- Policy implication highlighted in the appendix:
  - Alternative policy instruments, most obviously fiscal policy, can help sustain domestic demand in the home country.
  - However, fiscal policy may not be viable if there is a need for fiscal policy adjustment to ensure debt sustainability.

### Figures and equilibrium points (as described)
- Figure 1: Equilibrium exchange rate and interest rate — shows point A, labels including r*, r, e, YY = **, YY = *, 0 r, r* 0 r, 0 e.
- Figure 2: Impact of an increase in desired foreign saving — shows points A and B, labels including e’, r r* r’, YY = **, YY = *, r*’, 0 r, r* 0 r, 0 e.
- Figure 3: Increase in foreign saving, zero bound on interest rates — shows points A and C, labels including e’, r r* YY = **, YY = *, 0 0r = * 0 0r = 0 e, YY <.

*Source: _sdn1103 - References (PDF chapter/section).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2011/_sdn1103.pdf_