The 2016 External Sector Report (ESR), the fifth annual exercise of its type, analyzes recent developments and provides updated staff assessments of countries’ external positions, including current account balances, real exchange rates, external balance sheets, capital flows, and international reserves.
The ESR, which covers 29 of the world’s largest economies (representing about 85 percent of global output), comprises two papers:
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An overview paper that highlights global themes and multilateral issues, showing how individual economies fit into the global picture, and
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A set of individual external assessments, that provide a more granular country-specific discussion.
The ESR combines individual economy perspectives with a global perspective, said Luis Cubeddu, chair of the interdepartmental group that authored the report.
“The goal is to offer a multilaterally consistent assessment of external balances, currencies, and policies, building on the individual assessments we conduct of our member countries’ economies throughout the year,” Cubeddu said, noting that external flow and stock imbalances can have a significant impact on the operation of the global economy.
Latest developments
After narrowing in the aftermath of the global financial crisis and remaining fairly stable in recent years, external imbalances are again widening, the analysis revealed. These 2015 developments were driven by three main factors.
First, a stronger recovery in the United States and the United Kingdom—relative to Japan and the euro area—and the associated divergence over the expected path of monetary policy led to a strengthening of the U.S. dollar and sterling and a weakening of the euro and yen in 2015. Second, the sharp fall in commodity prices brought about a sizable redistribution of income across countries. A third driver was the tighter external financing conditions in emerging markets, as a result of concerns over the rebalancing process in China and prospects of rising interest rates in the United States.
Together, these factors shaped current account and exchange rate adjustments, the report said.
Not only did imbalances grow overall, the report found, but there has also been an increase in the extent to which current account surpluses and deficits now exceed their staff-assessed norms (i.e., the levels consistent with fundamentals and desirable policies). The increase in excess imbalances at the global scale was driven by larger excess surpluses in Japan and Germany, as well as higher excess deficits in the United States, United Kingdom and a few commodity exporting economies (Australia, Canada, Saudi Arabia). These were partially offset by a narrowing of excess imbalances in key emerging markets and euro area debtor countries.
The recent widening of global excess imbalances took place against a backdrop where such excess imbalances had not changed much in recent years. In particular, there has been little progress in reducing imbalances among the surplus economies like Germany, Korea, the Netherlands and Sweden. The observed persistence of imbalances suggests not only that these positions are slow moving, but also that not enough has been done to address them in recent years.
Policy challenges
Growing and persistent excess imbalances suggests that a more balanced policy approach is necessary. For many countries, especially those running excess surpluses, this means less reliance on monetary policy and more emphasis on fiscal and structural policies. “While monetary policy should remain accommodative where negative output gaps and deflationary pressures persist, it cannot be the only game in town,” the ESR stresses.
Surplus countries that have domestic slack need to rely more on fiscal policy easing, which would address both their output gaps and their external gaps, the report advises. That is not to say that monetary policy cannot be used, but that excessive reliance on it should avoided. Meanwhile, deficit countries should actively use monetary policy, where available, to close both internal and external gaps. Where policy space is more limited, greater reliance on structural policies will be necessary. On this point, the report provides structural policy advice tailored to a country’s domestic and external situation and features (see chart).
With most countries operating below potential, policies will need to be carefully calibrated to ensure the external adjustment is not globally contractionary. Emphasis needs to be given on demand-enhancing and not demand diverting policies, with surplus economies doing more to support global demand. A global collective effort may be necessary, especially if downside risks materialize, the ESR says.
