​Current Account Deficits During Heightened Risk: Menacing or Mitigating?

52 Pages Posted: 25 May 2016

See all articles by Kristin J. Forbes

Kristin J. Forbes

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Ida Hjortsoe

Bank of England

Tsvetelina Nenova

London Business School - Department of Economics

Date Written: May 20, 2016

Abstract

Large current account deficits, and the corresponding reliance on capital flows from abroad, can increase a country’s vulnerability to periods of heightened risk and uncertainty. This paper develops a framework to evaluate such vulnerabilities. It highlights the central importance of two financial factors: income on international investments and changes in the valuations of those investments. We show how the characteristics of a country’s international investment portfolio ‒ the size of its international asset and liability holdings, their currency denominations, their split between equity and debt exposures, and their return characteristics ‒ affect the dynamics of these financial factors. Then we decompose those dynamics into their drivers and explore how they are affected by domestic and global risk. We apply this framework to 10 OECD economies, showing the flexibility of this approach and how the countries’ different international investment portfolios generate different dynamics in international investment income and positions. These examples, including a more detailed assessment based on an SVAR for the UK, show that a substantial degree of international risk sharing can occur through current accounts and international portfolios. Our framework clarifies which characteristics of a country’s international portfolio determine whether a current account deficit is “menacing” or “mitigating”.

Keywords: current account, risk, international investment income, valuation effects

JEL Classification: F32, F21, F36, F42

Suggested Citation

Forbes, Kristin J. and Hjortsoe, Ida Maria and Nenova, Tsvetelina, ​Current Account Deficits During Heightened Risk: Menacing or Mitigating? (May 20, 2016). MIT Sloan Research Paper No. 5167-16. Available at SSRN: https://ssrn.com/abstract=2783917 or http://dx.doi.org/10.2139/ssrn.2783917

Kristin J. Forbes (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

Room E62-416
Cambridge, MA 02142
United States
617-253-8996 (Phone)

HOME PAGE: http://web.mit.edu/kjforbes/www

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ida Maria Hjortsoe

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Tsvetelina Nenova

London Business School - Department of Economics ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

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