current accounts matter

Judith Sloan hit the nail on the head in her Catallaxy post on Rory’s letter to the AFR – regarding Des Moore (you can read the full letter here).

One of Robertson’s major gripes (and I am not sure why he would even care from where he sits – good one, Des, you are having an impact) is that Des is inclined to issue dire warnings. In point of fact, it was Des, along with John Stone, who belled the cat on the rubbish that were the Club of Rome warnings.

Like most economists, Des has got some things right and some things wrong. He was right about the club of Rome and is still correct – the Stone Age didn’t end because we ran out of rocks!

While Des was wrong in the particular case about the Australian current account deficit in the 1980s, it was and still is good economics to keep an eye on large and persistent current account deficits.

A recent paper on this subject that I recommenced is Jorda, Schularick, and Taylor (2010) – Financial Crises, Credit Booms, and External Imbalances.

The Authors find that “credit growth emerges as the single best predictor of financial instability, but the correlation between lending booms and current account imbalances has grown much tighter in recent decades”.

So when might a large and persistent current account deficit be a warning of trouble to come? When you have a credit boom at the same time. That’s pretty much what happened in Australia.

The above chart is from a speech Bernanke gave in Jan’10 – in that speech Bernanke developed his ‘savings glut’ narrative, arguing that money flowing in drove current account widening and pushed up house prices around the world.

I am persuaded by Bernanke’s speech and various academic / IMF research that current accounts do matter – and that they are worth worrying about. It seems that financial systems are not always especially good at allocating capital – especially when there are sudden strong inflows.

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3 Responses to current accounts matter

  1. Matt C says:

    Interesting article. A bit like an imperfect markets, Austrian economics view of the world. The Austrian malinvestments story makes some sense to me but coukd never marry it to the Austrians view of perfect markets. If markets were perfect how do malinviestments occur?

  2. on your Marx says:

    Poor old Des, he was the centre of attention when Syntec was at its peak and then nothing.

    Rory undoubtedly remembers Des being mum about the large and growing structural budget deficits at the end of the ‘Howard’ era which led to rising inflation.

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