Assessing Global Imbalances: The Nuts and Bolts

IMF Blog, June 26, 2017

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Current account imbalances can be either healthy or a sign of macroeconomic and financial stress.
The IMF conducts annual external assessments to identify potential risks and offer policy advice to the world’s largest economies.
Objective: alert the global community to potential risks that countries need to address together.

Demographic-driven surpluses: Countries with rapidly aging populations may run current account surpluses to accumulate funds for retirement when domestic investment opportunities are limited.
Growth-driven deficits: Young, rapidly growing economies with ample investment opportunities can run current account deficits to finance investment, provided they can repay from future income.

Large external liabilities can create vulnerability to sudden stops in capital flows, forcing abrupt cuts in spending and increasing the likelihood of financial crises.
Persistent imbalances may reflect domestic distortions (for example, insufficient social safety nets causing excessive precautionary saving) that harm growth.
Global consequences: excessive surpluses can depress global demand and increase protectionist sentiment in deficit countries.

The Great Depression followed a failure of international cooperation to address persistent imbalances among surplus and deficit countries.
The global financial crisis was preceded by record imbalances and neglected buildup of vulnerabilities; the unwinding occurred through a once-in-a-generation recession.

Since 2012, the IMF conducts systematic, annual external assessments for the world’s 28 largest economies and for the euro area.
These economies account for more than 85 percent of world GDP.
Results are featured in Article IV consultation reports and in an annual External Sector Report.
Focus: multilateral—transactions with the entire rest of the world rather than bilateral balances—to uncover macroeconomic drivers of global imbalances.

Step 1: Projected current account.
- Start with the External Balance Assessment (EBA) model to estimate the “average” current account balance given characteristics (for example, demographic structure or income level) and policies (for example, the fiscal stance).
- Complementary checks: run similar models for the real effective exchange rate to derive a benchmark for assessments of under- or overvaluation.
Step 2: EBA norm.
- Replace actual policies with “desired” policies in the EBA model to compute the current account balance that would prevail if policy were appropriate (the current account norm).
Step 3: Staff-assessed norm.
- Adjust model estimates for omitted country-specific factors based on country team insights from consultations.
- Example: a young, rapidly developing economy whose model-implied deficit is larger than it can typically finance may have the estimated current account norm adjusted upward (toward a lower deficit).
- Adjustments are made to be as accurate and impartial as possible and to be multilaterally consistent (they add up globally).
Step 4: Current account gap.
- Defined as the difference between the actual current account balance and the staff-assessed norm.
- The gap captures everything driving an economy’s external balance away from its appropriate level—from inadequate macroeconomic policies to domestic distortions.
- Gaps are translated into qualitative assessments to inform policy discussions about closing them.

External assessments are snapshots in time; both norms and current account balances evolve.
Confidence bands are placed around assessments to account for uncertainty.
Acknowledged potential for error and omitted factors; the IMF continually upgrades and refines the EBA model and analysis.
The assessments are an analytical tool to inform cooperative policy action rather than definitive judgments.

Early identification of risky external developments facilitates policy advice to reduce potential disruptive imbalances.
Countries should address domestic distortions (for example, strengthen social safety nets) that create excessive precautionary saving.
Cooperative international action is necessary: combating excess global imbalances is a joint responsibility and requires multilateral cooperation to avoid crises that derail global stability.

Source: IMF blog post “Assessing Global Imbalances: The Nuts and Bolts” by Maurice Obstfeld, June 26, 2017.

The External Balance Assessment
- The External Balance Assessment (Markdown version)
- The External Balance Assessment (PDF)