• By
  • David Wessel

Olivier Blanchard, chief economist of the International Monetary Fund, sees a teachable moment in the running debate within the Group of 20 leading economies over dangers of large current-account surpluses and deficits, the broadest measures of nations’ trade balances.

So Mr. Blanchard, on leave from the Massachusetts Institute of Technology, is offering a seven-page essay titled “(Why) Should Current Account Balances be Reduced?” The IMF is due to publish this essay, co-authored with IMF colleague and Harvard-trained economist Gian Maria Milesi-Ferretti, on Tuesday.

The bottom line: “One may argue that every country has the right to be wrong so long as it doesn’t cause harm to others.”

Without naming names, they cite three sets of circumstances in which there is a risk of such harm.

(1) Large current-account deficits, by definition, require the economy running them to import a lot of capital from abroad. If, for some reason, the foreign capital stops coming suddenly, “these evidences often lead to large financial disruptions” that can affect many countries. This, they say, argues for “surveillance”–among the IMF’s favorite words–not only on the magnitude of current-account deficits but on a broader set of indicators.

(2) Large current-account surpluses reflect “unfair competition,” that is a combination of a low exchange rate coupled with low domestic demand that is economically quite similar to tariffs-cum-export subsidies. Tariffs imposed to this end are illegal under the World Trade Organization rules. (Can you say: C-H-I-N-A?)
So should the same be true of cheap currencies and high savings rates that reduce domestic demand? It depends. “Proving intent– namely, that surpluses reflect a deliberate strategy designed to gain competitive advantage–is likely to be difficult. Ignoring intent may be politically unacceptable.”

(3) When part of the world economy is trapped in an economic circumstance in which interest rates are at zero and can’t fall any further (can you say U-S-A or Japan?), then “a larger current account surplus in a given country reduces demand and output in other countries and thus affects them adversely.”

This concern, the IMF economists say, is “logically well founded.” When interest rates cannot decline in other countries in response to an increase in global savings–”as is arguably the case in several large advanced economies”–then a large current-account surplus in one (obviously, China) can lead to lower demand and lower output in others. This case, they note, is specific to the current moment in economic history, and isn’t likely to prevail for long.

Multilateral surveillance — essentially peer pressure with facts — can be useful and important, Blanchard and Milesi-Ferretti concludes, when are spillover effects from deficits or surpluses.

Surveillance by the IMF or the G20, they say, can (a) provide a forum for discussions of differences in nations’ assessments of current conditions and (b) “as a potentially useful commitment device for countries to implements some of the required but politically unpalatable fiscal or structural adjustments,” an approach, they note, now being attempted by European economies that share the euro and thus are vulnerable to damage from each other’s unsustainable policies.

Class dismissed.



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