Commentary Type

Breaking Up Is Hard To Do: Global Co-dependency, Collective Action, and the Challenges of Global Adjustment

Catherine L. Mann (Monetary Policy Committee, Bank of England)

Article published in the CESifo Forum


Global imbalances have continued, indeed deepened, far longer than both researchers and pundits would have thought. On the US side, the current account deficit at about $630 billion (2004q1-3, AR) and 5.5 percent of GDP (2004q3) falls outside the oft-quoted range of 4-5 percent after which, research on industrial countries suggests, economic forces tend to narrow the imbalance. There is somewhat less research on the persistence of global imbalances from the standpoint of the rest of the world, in part because individually most of those imbalances are not so notable. Clearly though, collectively growth in the rest of the world has come to be co-dependent on US demand patterns.

Three frameworks for analysis

There are several frameworks to analyze these imbalances. The first framework analyzes the external imbalances from the standpoint of export and import flows. Second, underlying the external imbalances are internal imbalances in both countries and regions with respect to savings and investment, that is, domestic demand and production. Third, these real-side imbalances are reflected in the composition and distribution of financial portfolios of assets and supported through exchange rate regimes. Thus there are three frameworks in which to analyze global imbalances: the international framework (trade and current account imbalances); the domestic framework (savings vs. investment and domestic demand vs. production); and the financial framework (investor choice over portfolios of assets).

Regardless of the exact point where economic forces push back hard, few suggest that the trajectories for the US imbalances (international, domestic, and financial) are sustainable, although which of the trajectories bites first is open to contention. And neither is the collective path for the rest-of-the-world. That no other country faces as significant a quantitative change to their trade balance as the United States should not imply ease of adjustment. In fact, just the opposite could be the case as each country, facing the policy choices and structural challenges to reorienting demand, production, and financing, could argue that someone else should ‘go first’.

In fact, beginning in 2002, the dollar started to depreciate, most notably against the euro, in effect forcing the Euro-area countries to start the process of adjustment of global trade and domestic demand. However, for a second block of currencies in Asia, currency market forces are more muted. For them, a coordinated action to allow internal and external adjustment may be necessary to break-up the global co-dependency and return global growth to a more balanced footing.

In sum, the collective co-dependency between the US and the rest-of-the world has enabled the international, domestic, and financial global imbalances to persist longer than they otherwise would have. Although the dollar began a generalized depreciation in 2002, suggestive that a break-up of the global co-dependents was underway,the distribution of the depreciation has been uneven in ways consistent with macroeconomic frameworks of analysis. Breaking-up is hard to do, particularly if that involves collective action on the part of some policy markers.

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