Accounting for Global Dispersion of Current Accounts

IMF Working Papers, December 1, 2009

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The paper undertakes a quantitative analysis of the dispersion of current accounts in an open economy version of an incomplete insurance model, incorporating important market frictions in trade and financial flows.
Calibrated with conventional parameter values, the stochastic stationary equilibrium of the model with limited borrowing can account for about two-thirds of the global dispersion of current accounts.
The easing of financial frictions can explain nearly all changes in the current account dispersion in the past four decades.
The easing of trade frictions has almost no impact on the current account dispersion.

Framework: open economy, incomplete insurance model.
Key features: incorporates market frictions in trade and financial flows; allows limited borrowing.
Calibration: uses conventional parameter values.
Equilibrium concept: stochastic stationary equilibrium.

Contribution of the model: explains about two-thirds of global current account dispersion under the calibrated setup.
Role of financial frictions: easing financial frictions accounts for nearly all observed changes in current account dispersion over the past four decades.
Role of trade frictions: easing trade frictions has almost no impact on current account dispersion according to the model.

Financial market integration and the relaxation of financial frictions are central to understanding changes in global current account dispersion.
Policies that materially affect financial frictions are likely to have larger effects on cross-country dispersion of current accounts than policies that primarily reduce trade frictions.

Authors: Jaewoo Lee, Yongsung Chang, Sun-Bin Kim. Publication date: December 1, 2009.