Greenspan, Alan ; Interest rates ; Deficit financing

Catherine L. Mann

English

Research Papers in Economics

Sebastian Edwards’ paper masterly reviews the consequences for
GDP growth, interest rates, and currency value when current
accounts that are in deficit adjust. But, for all the episodes, countries,
and time periods that he examines, it remains true (as he cautions)
that the United States is different from other countries. It is more
closed, a larger borrower (both as a share of GDP and in level terms),
and of greater importance in the global economy. Hence, examining
the adjustment process of any other country has limited relevance for
understanding the nature of the adjustment process that is going to
take place, at some point, in the United States.
In my commentary, I rephrase and address Sebastian’s question as:
How will our current account imbalances end? A disaggregated
perspective on the U.S. current account helps to better understand the
nature of both the widening and potential closure of the current
account. Moreover, the phrase “our imbalances” implies that we
should consider both the U.S. deficit as well as the rest-of-world coun-
terpart. At the end of this commentary, I consider the issue of current
account adjustment in the context of this conference’s main topic,
which is “Legacy of the Greenspan Era: Lessons for the Future.”
Catherine L. Mann
Commentary: The End of Large Current
Account Deficits, 1970-2002: 
Are There Lessons for the United States?
277To summarize, a disaggregated perspective of U.S. trade reveals
persistent trends in country and product components of U.S. trade,
bilateral and global trends in foreign trade, and in current account
surpluses. A new database of product- and country-specific trade flows
and prices and matched expenditure components of GDP yield new
estimates of growth and relative price elasticities of trade. Collectively,
new estimates and data point to a significant challenge in building up
from a disaggregate basis the turnaround in the trajectory of the U.S.
current account predicted by many macroeconomic analysts. 
This is not a commentary that the current account trajectories should
or will continue, just that macroeconomic analyses may underestimate
the consequences or difficulty of realizing the turnaround in the geog-
raphy of production and components of demand that “must” take place
to achieve the change in current account trajectory and magnitude.
Implied assumption regarding exchange rate behavior, regime change,
and pass-through may be equally implausible.  
Hence, the importance of policy awareness and the potential chal-
lenge of policy response are significant. The legacy of the Greenspan
era may be, counter-intuitively, that policymakers are less prepared,
not more so, to deal with the end of our imbalances.   
Overview of where the global imbalances come from
Charts 1 and 2 display, from a U.S. perspective, how we have gotten
to this point of a current account deficit of about 6 percent or so of
GDP. The external deficit is driven essentially by consumption habits
in the United States. The last 25 years reveal a persistently widening
deficit on trade in consumer goods and autos deficit that, up until the
most recent increases in energy prices, have accounted for nearly the
entire trade deficit and therefore the entire current account deficit as
well (Chart 1). One reason for the widening of these components of
the trade deficit is the persistent decline in household savings (Chart
2), which underpins consumption-based domestic demand. 
278 Catherine L. Mann
 Commentary 279
Chart 1
U.S. Trade Deficit: A Disaggregated Perspective
Chart 2
NIPA: A Disaggregated Perspective
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Net Household Savings Net Corporate Savings Net Public Savings
Net Foreign Savings Net Investment Net National Savings
Source: Bureau of Economic Analysis
Sources: Bureau of Economic Analysis, National Income and Product Accounts; International Transactions
Accounts; and Catherine MannOver the years, consumption has been bolstered as well by equity
wealth, tax cuts, and housing wealth. If the personal income tax cuts
do not sunset, additional consumption impetus will likely feed
through in the future. Notably, the decline in household savings and
widening of the trade deficit persists during periods of fiscal deficit
and surplus. Hence, rather than the fiscal position, it appears that it
is the nature of expenditure and revenue that matters. 
Chart 3 and Table 1 show the global imbalance from the perspec-
tive of the rest of the world. The persistent widening of the U.S. trade
deficit is widely distributed around the world (Chart 3). The United
States has a widening bilateral trade deficit with virtually every
country and region around the world. The counterpart of the United
States trade deficit is not just a deficit with respect to China, but also
a deficit with respect to the countries of the European Union and just
about all other countries and regions. 
These bilateral surpluses by themselves do not imply that there is an
imbalance in the rest of the world that has to be solved; rather, the
bilateral trade positions could simply reflect the U.S. consumption
boom. But the current accounts as a share of GDP (Table 1) tell the
important story for the rest of the world. There is a persistent trend
toward current account surplus in the rest of the world, particularly
evident in Asia. So, it is not simply the case that the U.S. trade deficit
is homegrown from robust consumption; it is as well a consequence
of the nature of demand and production composition abroad.
This pattern of consumption-based demand in the United States and
export-based surpluses abroad is a “codependent relationship.”1 The
United States, for a generation-long period of time, has been able to
persistently consume more than we produce (domestic demand is
greater than production), and that is matched by a persistent trend
toward domestic demand less than production abroad and a dependence
on exports to the United States, a habit which is distributed widely,
although is most obvious in Asia. It is a codependent relationship in the
sense that collectively our habits balance each other out and prop each
other up. 
280 Catherine L. Mann
 Commentary 281
Current Accounts as a Share of GDP
1980 1985 1990 1998 2004 2005(p)
China 0.1 -3.7 3.1 3.3 4.2 4.1
Japan -1 3.8 1.4 3 3.7 3.3
Asia/Pacific -3 -0.4 -0.6 4.5 4.2 3.5
Western Europe -1.3 0.6 -0.3 1.1 0.8 0.8
Latam/Carib na na -0.1 -4.5 0.8 0.2
-200
-150
-100
-50
0
50
1980 1985 1990 1995 2000 2004:II
Europe Canada
Mexico Japan
China Asia without China and Japan
Latin America without Mexico
Chart 3
Bilateral Trade Deficits
Table 1
Current Account Surpluses Around the World
Individually these trends are not sustainable. Our current account
deficit is not sustainable for the reasons that Sebastian details in his
paper and that have been widely discussed as well by others.2 Perhaps
less well-acknowledged, the current account surpluses abroad should
not be viewed as sustainable either. Persistent current account surplus
undercuts domestic investment and development, expansion of GDP
per capita, and productivity growth in the rest of the world. So, this
relationship is codependent in a negative way, even as it persists and
hence has a sense of familiarity and structural inevitability. 
Source: Bureau of Economic Analysis
Source: IMF World Economic Outlook, April 2005The standard approach to understanding current account sustain-
ability and adjustment has focused on GDP as the measure of
economic activity and aggregate imports and exports. The analysis
presented here identifies three disaggregations that matter: type of
traded product, trading partners, and type of expenditure (demand).
We have developed a new data set with country-specific, product-
specific, and expenditure-specific series to estimate the relevant
demand and relative price elasticities for disaggregated trade flows and
sustainability analysis.3 
New estimation with components of domestic demand and disaggre-
gated products in trade reveals the importance of the structure of
economic activity and relative prices for different trading patterns in the
global economy. Selected regression results for two product categories
and different country groups detail some of the results (Table 2).  The
main result is that this more disaggregated analysis of U.S. trade gives a
better view of some of the elasticities that frequently are used to project
the U.S. external accounts. Using matched expenditure components
reveals that elasticities differ across product and country groups. They
are especially high in the short run for consumer goods, although long-
run elasticities eliminate much of the Houthakker-Magee asymmetry
between imports and export income elasticities. Using matched relative
price (for example, real exchange rate) elasticities reveals significant and
plausible values for industrial countries, particularly with respect to
consumer goods (luxuries?) from industrial countries. But, the relative
price mechanism to switch demand is not statistically significant for
developing countries. 
Using the new estimated elasticities and assumptions for consump-
tion and investment from Consensus Economics Forecasts allows
construction of illustrative scenarios for how U.S. current account
adjustment might proceed going forward (Chart 4 and Table 3). Given
the elasticities, the Consensus Economic Forecasts, and no additional
dollar depreciation, the real non-oil trade deficit in 2006 would be
about $725 billion. 
282 Catherine L. Mann
 Commodity  Matched Expenditure Matched Relative Price Variety
group
Industrial Developing Industrial Developing 
Country Country Country Country
SR LR SR LR SR LR SR LR
Imports
Capital 1.29** 0.77** -0.40# 3.12 -0.31 -0.71** -0.20 5.01** 1.42**
goods
Consumer 3.55 1.32 4.16** 1.96# -1.35**-4.34** 0.86* 14.34**-0.19
goods
Exports 
Capital 0.67 0.70* 0.79** 0.94** -0.38** 0.12 -0.01 0.01 5.2**
goods
Consumer 0.45** 1.09** 0.69** 1.64** -0.45** -0.58# 0.01 0.02 -0.12
goods
A rest-of-world investment boom and a rest-of-world consump-
tion boom (as detailed in Table 3, where “boom” is defined as the
average high value for consumption or investment over the 1980-
2003 period) yield some narrowing of the trade deficit. But, since
most of our capital goods exports go to mature industrial markets,
whose average booms are modest, our capital goods exports do not
increase that much. And, since the share of consumption goods in
U.S. exports is relatively small, booming consumption abroad does
little to improve the trade account. Overall, global consumption
and investment booms do not play a very large role in narrowing
the trade deficit because the geographical and commodity patterns
of trade on the export side have been remarkably stable for 25 years. 
Commentary 283
Table 2
Selected Regression Results:
Two Product and Two Country GroupsConsensus  2005 2006 Add % Points to  Average for “Boom” in ROW/
forecasts Achieve “Realistic Slowdown” 
(real growth, pp) for the U.S. 
(Based on 1980-2003 Data)
Gross Fixed Capital Formation
Europe and Japan 3.5 3.7 5.0 8.4
Other industrial 7.4 7.2 7.0 14.8
countries
Developing 9.2 7.5 1.0 9.9
countries
United States 8.8 7.5 -13.0 -6
Personal Consumption Expenditures
Europe and Japan 1.3 1.7 7.0 8.3
Other industrial 3.1 3.1 5.0 8.3
countries
Developing 4.9 4.4 11.0 15.2
countries
United States 3.5 3.1 -3.0 0
284 Catherine L. Mann
Chart 4
Illustrative Scenarios to Close the Trade Deficit
Table 3
Assumptions for Growth Scenarios
Ending the Current Account Deficit: Illustrative Scenarios
Projected Real Trade Deficit (Ex., Oil), Using Commodity-Specific Elasticity Estimates
-350
-400
-450
-500
-550
-700
-750
-600
-650
2003 2004 2005 2006
Assume Consensus Economics 
forecasts for all RHS variables
Assume boom in I abroad (with Consensus
forecasts for C)
Plus assume boom abroad both in I and C
Plus assume U.S. investment bust with 
Consensus forecasts for C
Plus assume bust both for U.S. I and C
Macroadvisers’ forecasts for real X and M 
growth*
U.S. Consumption
slowdown
U.S. Investment
slowdown
}
}
$ Billions
Note: These scenarios assume an average boom for foreign countries but only a realistic slowdown for
the United States; to achieve an “average” recession for the United States, I would fall an additional
13 pp and C an additional 3 pp.Commentary 285
Instead, and in keeping with what Edwards found in his exercise for
largish industrial countries, investment and consumption slowdowns
in the United States (dropping 13 percentage points and 3 percent-
age points from the Consensus Economics assumptions) stabilize the
real trade deficit. These are modest slowdowns for the United States
compared to historical cycles in the 1980-2003 period. Even so, the
last time consumption growth slowed to zero was the recession of
1991-1992. If the United States had an average consumption reces-
sion—which of course we haven’t seen for quite awhile—and an
average investment recession (based on average cycles from 1980-
2003), then the real trade deficit would be close to zero. 
What do I conclude? I will make two sets of conclusions: one on
the adjustment process based on the new estimation and illustrative
scenarios and one with regard to the theme of the conference, the
legacy of the Greenspan era. 
On the adjustment process:  
• The trajectory of the U.S. current account has the tyranny of
imbalance, whereby exports must grow more than twice as fast as
imports just to keep the deficit from worsening. It faces inex-
orable elements of U.S. trend robust consumption and
rest-of-world trend export dependence. 
• Average global booms improve U.S. net exports, but by relatively
little because the United States does not export its most impor-
tant products to the fastest growing markets. Why this is so is an
interesting question for future research.
• A realistic slowdown for the United States dramatically narrows
the trade deficit. Hence, the U.S. deficit is mostly homegrown,
and absent significant changes in geography or composition of
trade, any significant improvement also must be homegrown. 
• What about a role for the exchange value of the dollar? Based on
our estimates, the exchange rate plays an important role in expen-
diture switching for industrial countries, but it has little empirical
significance for exports to or imports from developing countries,
for which real exchange rates have moved relatively little. 
 • Hence, exchange rate management, magnitude of changes,
and pass-through have to be different from here-to-fore
observed for exchange rates to play a significant role in current
account adjustment. 
With respect to the legacy, our codependent relationship has been
fostered by globalization enhanced by technological innovation,
which on the U.S. side is reflected in productivity growth in an
increasingly responsive U.S. marketplace and sophisticated financial
intermediation, which have allowed our consumption habits to
persist for an extended period of time. Our side of the codependency
is abetted by the rest of the world favoring a production-based and
export-led growth strategy. For more than a full generation,
consumers, investors, and producers, and multiple generations of
policymakers and politicians both here in the United States and
abroad, have had, as a backdrop to their decisionmaking, a very deft
handling of these forces by Chairman Greenspan’s Federal Reserve. 
The virtues of the Greenspan Federal Reserve are clear: rapid
growth with few recessions or recessionettes, stable and reduced price
inflation, and low interest rates. But, there is this glaring and very
large imbalance manifested here and abroad. To at least some degree,
the very deft handling on our side of the policymaking arena has
taken policymakers abroad off the hook to engage their own domes-
tic demand management and structural reforms.
Going forward, will the next Federal Reserve chairman be able to
manage these forces as deftly? If not, on whom will the adjustment be
most difficult? Will it be the United States, as the illustrative scenar-
ios might suggest, or will it be abroad? Whereas the United States
may well need to reduce domestic demand, the implication is that
many other countries around the world will need to increase domes-
tic demand—and it is not obvious which is more difficult to do or to
adjust to. Sebastian Edwards’ paper argues that history is unkind to
some countries with large imbalances. But, in the case of the adjust-
ment of our global imbalances, it is less clear on whom the requisite
adjustment will be most unkind.4
286 Catherine L. Mann
 Endnotes
1“Managing Exchange Rates: To Achieve Global Re-balancing or As Evidence of
Global Co-Dependency?” Business Economics, June 2004. 
2See also other analyses of sustainability from a domestic and a financial-market
perspective: “Perspectives on the U.S. Current Account Deficit and Sustainability,”
Journal of Economic Perspectives, Summer 2002; and “How Long the Strong
Dollar?” in Dollar Overvaluation and the World Economy, C. Fred Bergsten and John
Williamson, eds. Institute for International Economics: Washington, 2003. 
3“The U.S. Trade Deficit: A Disaggregated Perspective,” prepared for NBER
conference volume G-7 Current Account Sustainability and Adjustment, Richard
Clarida and Martin Feldstein conveners (May 2005), with Katharina Plück.
4This is a paraphrase of “history has not dealt kindly with the aftermath of
protracted periods of low-risk premiums.” Chairman Alan Greenspan, Opening
Remarks, at a symposium sponsored by the Federal Reserve Bank of Kansas City,
Jackson Hole, Wyo., Aug. 26-27, 2005.
Commentary 287
 

Commentary : the end of large current account deficits : 1970-2002 : are there lessons for the United States?

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Commentary : the end of large current account deficits : 1970-2002 : are there lessons for the United States?

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