The US current account deficit may be near optimal levels based on expected economic growth trends among wealthy countries, according to a study co-authored by a Federal Reserve economist.
Dramatic growth in the US share of gross domestic product - net of investment and government spending - among wealthy countries has been ‘one of the most striking economic developments of the last 25 years,’ according to the study by Fed economist John Rogers and University of Wisconsin Professor Charles Engel.
While noting major caveats, the study finds, ‘The size of the US current account deficit may be justifiable if markets expect further growth in the US share of advanced-country GDP.’ A country’s current and expected-future share of world economic output determines its optimal ratio of consumption to output, Engel and Rogers say.
The authors say their modeling could contain important flaws undermining the idea that the US current account reflects optimal consumer decisions. If simplifications and assumptions in the study are wrong, ‘it may turn out, as many have been warning, that the deficits have put the US on the path to ruin,’ the economists say.
The study’s findings could falter if East Asian economies reverse their role as large net savers and lenders in international capital markets, or if the US loses the ‘exorbitant privilege’ that allows it to earn higher rates on its foreign investments than foreigners earn on investments in the US, they say.
The economists also say they were unable to reach firm conclusions about the path of foreign exchange rates over the next 25 years.
But their study cites long-term economic growth trends that appear to justify the size of the US current account deficit relative to economic growth expectations.
The US share of net GDP among the Group of Seven plus Switzerland, Sweden and Norway has grown to about 44% in 2004 from about 39% in the late 1970s. The study’s baseline projection shows this share is expected to grow at a slower pace to 47% in the next 25 years, according to the working paper study, released this month by the National Bureau of Economic Research.
Since 1993 consensus long-term forecasts have consistently and widely underestimated US economic growth relative to G7 countries as a whole, the study says. ‘The current forecasts for the future, however, show that the markets expect a large increase in US share of GDP - almost precisely the amount that we calculate would make the current level of deficit optimal,’ it says.
Federal Reserve Chairman Alan Greenspan and other Fed officials have said recent sharp growth in the US current account deficit - the broadest gauge of the country’s trade gap with the rest of the world - can’t persist indefinitely. The deficit reached $195.8 billion, or 6.2% of GDP, in the third quarter of 2005, and it is expected to have hit a record for 2005 as a whole.
In a speech last month, Greenspan suggested he has become less concerned about the trade deficit’s potential to spark financial market turmoil because the deficit stems partly from a global increase in cross-border trade and investment. But he also warned of dangers from unchecked US government budget deficits and the potential for protectionist barriers to international trade. (Dow Jones)