Current Account Imbalances Coming Back

Working Paper
11-1
January 2011

Joseph E. Gagnon argues that current account imbalances in the major G-20 economies are likely to widen over the next few years, despite the public commitments of G-20 leaders to reduce them. Gagnon bases this forecast on a statistical model that builds upon and improves previous explanations of current account imbalances in the academic literature. A key advance is that the model captures the effect of external financial policies, including exchange rate policies, through data on net official financial flows. If future economic policies follow the paths projected by the International Monetary Fund (IMF), the model predicts that current account imbalances in many economies will widen substantially more than predicted by the IMF. Nevertheless, the paper agrees with the IMF on the types of policy changes required to prevent widening imbalances, namely fiscal consolidation in deficit economies and exchange rate flexibility and structural reforms in surplus economies.