NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Current Account Deficits During Heightened Risk: Menacing or Mitigating?

Kristin Forbes, Ida Hjortsoe, Tsvetelina Nenova

NBER Working Paper No. 22741
Issued in October 2016
NBER Program(s):International Finance and Macroeconomics, Monetary Economics

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, and their return characteristics – affect the dynamics of these financial factors. Then we decompose those dynamics into their drivers, explore how they are affected by domestic and global risk shocks, and apply this framework to 10 OECD economies. These examples, including a more detailed assessment for the UK, show that a substantial degree of international risk sharing can occur through current accounts and international portfolios. Our flexible framework clarifies which characteristics of a country’s international portfolio determine whether a current account deficit is “menacing” or “mitigating”.

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Document Object Identifier (DOI): 10.3386/w22741

Published: Kristin Forbes & Ida Hjortsoe & Tsvetelina Nenova, 2017. "Current Account Deficits During Heightened Risk: Menacing or Mitigating?," The Economic Journal, vol 127(601), pages 571-623.

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