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Meaning of the Current Account Deficit

Meaning of the Current Account Deficit. Current Account Facts. Current account deficit exceeds seven percent of GDP, Double what it was in 2000. (The highest previous deficit of 3.8% of GDP occurred in 1872)

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Meaning of the Current Account Deficit

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  1. Meaning of the Current Account Deficit Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  2. Current Account Facts • Current account deficit exceeds seven percent of GDP, • Double what it was in 2000. (The highest previous deficit of 3.8% of GDP occurred in 1872) • With the exception of 1991, the US has been running current account surplus since 1975. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  3. Current Account: • Exports – Imports + net transfers between US and foreign countries) • Savings - Investment • GDP – Domestic absorption (Consumption + Investment + Government Expenditures + Imports) • Change in the Net International Investment Position (Change in Net Foreign Claims on the US economy) Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  4. Exports and Imports as a Percentage of GDP Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  5. CA= S - I • The U.S. Gross saving rates is the lowest of any industrialized country in the world. • Personal saving is currently negative. For the second quarter 2006 personal saving as a percent of disposable income was -.7% • Gross saving: personal saving plus business saving plus government saving (surplus): 13.55% Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  6. Gross Saving and Gross Domestic Investment as a Percentage of GDP Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  7. The net international investment position • The net international investment position, the net debts owed to the rest of the world, is approximately 25% of GDP. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  8. Net International Position of the US Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  9. Domestic Absorption • Domestic Absorption: Consumption + Investment + Government + Imports • Domestic Absorption exceeds GDP by the current account • US spends more than it produces Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  10. Domestic Absorption and Consumption as a % of GDP Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  11. Orthodox economic theory: • Perpetual Current account deficit is impossible. • A country is like an individual: • A country that runs a current account deficit in the present must run a surplus in the future. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  12. Why hasn’t the dollar fallen to correct these imbalances? • Japan • China • Ben Bernanke’s Explanation • US low Savings Rates Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  13. Consumption as a Percentage of GDP • Year Japan China U.S. • 1995 56.50% 46.05% 67.26% • 1996 55.85% 47.05% 67.25% • 1997 56.06% 46.54% 66.80% • 1998 57.05% 46.73% 67.22% • 1999 57.40% 47.58% 67.78% • 2000 56.68% 48.02% 68.65% • 2001 56.89% 47.19% 69.66% Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  14. The meaning of the current account deficit • Purchase the surplus production of the rest of the world Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  15. Gross Domestic Saving as a Percentage of GDP Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  16. Consumer Credit as a % of Disposable Income Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  17. Consumption and Consumer Credit (Blue Line) as a Percentage of GDP Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  18. Mortgage Debt as a % of GDP Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  19. Household Financial Obligations as a Percent of Disposable Personal Income Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  20. Uncharted waters. • Never has the world’s reserve currency country run such massive deficits. • The International Monetary Fund in its World Economic Outlook (2005) • concludes that the large U.S. current account deficit means that “ultimately exchange rates and trade balances will need to adjust, and adjust substantially". Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  21. Reducing the deficit • Increase in spending by the rest of the world • An increase in saving by the US Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

  22. Prospects for the future: • A continued decline in the value of the dollar seems likely • Reductions in the CA deficit are generally associated with recession in the US. Recession in the US generally means recession abroad • Decline in housing prices: • Increase in housing prices account for 1/3 of the increase in consumer spending in recent years • Decreases in housing prices imply decline in consumer spending Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu

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