The Transfer Problem in Reducing the U.S. Current Account Deficit

Type:
SCID Working Paper 326

Author(s):

Published:
05/1/07

Region:
General

Download:

Abstract:
Correcting global trade imbalances is one form of the transfer problem: spending must be transferred from trade-deficit countries (mainly the United States) to trade-surplus countries. Reducing the U.S. current account deficit requires that net saving be increased in the United States and reduced abroad, especially in Asia. But contrary to most literature on the subject, exchange rates need not, and probably best not, be changed as part of the transfer process to improve the U.S. trade balance. To show why this is so, the paper draws on the older literature on the transfer problem associated with paying war reparations. Adjustment in absorption, i.e., aggregate spending, is two-sided because the loser (the transferor) must raise taxes to pay an indemnity to the winner (the transferee), which then spends it. But there is no presumption that the terms of trade must turn against the transferor. That is, the losing country, which is forced into running a trade surplus (or smaller deficit), need not depreciate its real exchange rate to effect the transfer.