What Shapes Current Account Adjustment During Recessions?

IMF Working Papers, July 30, 2021

Source details

Study of external account dynamics during 278 economic recession events in the past 60 years.
Economic recessions trigger highly-persistent increases in the current account.
The initial driver of current account strengthening is a sharp decline in investment, followed by medium term deleveraging.
Effects are stronger in advanced economies than in emerging markets.
Strengthening of the current account is more pronounced when internal and external imbalances are present, and less pronounced when recessions are synchronized across countries.
During severe natural disasters or epidemics, current accounts tend to weaken in the short term.
The COVID-19 shock, characterized by comparatively moderate pre-existing imbalances yet high synchronization, had a muted effect on current account balances.
Compositional changes during COVID-19 were unique: record public dissaving more than offset exceptional private saving.

Sample and scope:
- 278 economic recession events over the past 60 years.
Main dynamics:
- Highly-persistent increases in the current account following recessions.
- Initial, sharp decline in investment is the primary immediate channel.
- Medium term deleveraging fuels continued current account strengthening.
Cross-country and event heterogeneity:
- Stronger adjustment in advanced economies than in emerging markets.
- Larger current account strengthening when internal and external imbalances exist.
- Smaller strengthening when recessions are synchronized across countries.
- Short-term weakening of current accounts during severe natural disasters or epidemics.

Investment channel:
- Sharp decline in investment at recession onset drives immediate current account improvement.
Deleveraging channel:
- Medium term deleveraging sustains current account strengthening.
Policy and sectoral composition (COVID-19 example):
- COVID-19 featured unique compositional changes driven by unprecedented policy intervention.
- Record public dissaving during COVID-19 more than offset exceptional private saving.

The presence of pre-existing imbalances amplifies current account strengthening during recessions.
High synchronization of recessions across countries dampens current account adjustment.
Natural disasters and epidemics can reverse typical recession-driven current account improvements in the short term.
Policy responses (public dissaving) can markedly alter the usual private-sector driven compositional shifts in external accounts.

Source: What Shapes Current Account Adjustment During Recessions? (IMF Working Paper by Christina Kolerus, July 30, 2021).