A central economic challenge of the first decade of the third millennium is “global rebalancing” – the re-alignment of current account balances between the three key economic regions of the US, the Euro area, and East Asia. There is a large theoretical literature that explains how current account balances (the trade balance plus net income from assets abroad) should evolve in idealized economies. However, that literature has been largely unsuccessful in empirically explaining real-world experiences.

Interestingly, movements in developing country current account balances have proven to be more amenable to statistical analysis than the corresponding developed country experiences. These differing results may be attributable to the special characteristics of developed economies, including perhaps the ability of the governments to borrow in their own currencies, and the use of their currencies as foreign exchange reserves by central banks around the world.

This project seeks to develop new theoretical models appropriate to determining what size of current account deficits can be sustained on a long term basis without incurring damage to the domestic and global economy. The collaborative will consider the importance of factors such as output growth, the size of government budget deficits, the conduct of monetary policy, and the development of financial systems. It will also assess how empirical methods can be used to validate or falsify the models forwarded.