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One of the major debates in open economy macroeconomics is the extent to which capital inflows are beneficial for growth. In principle, these flows allow countries to increase their consumption and investment spending beyond their income by enabling them to tap into foreign saving. Periods of such borrowing, however, are associated with large trade deficits, external debt accumulation, and, in some cases, overheating when these economies operate beyond their potential output level for an extended period of time. The relevant question in this context is whether the rate at which a country is taking on external debt has useful predictive information about financial crises.
China lends to the rest of the world because it saves much more than it needs to fund its high level of physical investment spending. For years, the public sector accounted for this lending through the Chinese central bank’s purchase of foreign assets, but this changed in 2015. The country still had substantial net financial outflows, but unlike in previous years, more private money was pouring out of China than was flowing in. This shift in private sector behavior forced the central bank to sell foreign assets so that the sum of net private and public outflows would equal the saving surplus at prevailing exchange rates. Explanations for this turnaround by private investors include lower returns on domestic investment spending and a less optimistic outlook for China’s currency.
The rise in oil prices from near $30 per barrel in 2000 to around $110 per barrel in mid-2014 was a dramatic reallocation of global income to oil producers. So what did oil producers do with this bounty? Trade data show that they spent about half of the increase in total export revenues on imports and the other half to buy foreign assets. The drop in oil prices will unwind this process. Oil-importing countries will gain from lower oil bills, but they will also see a decline in their exports to oil-producing countries and in purchases of their assets by investors in these countries. Indeed, one can make the case that the drop in oil prices, by itself, is putting upward pressure on interest rates as income shifts away from countries that have had a relatively high propensity to save.
The United States has been borrowing from the rest of the world since the mid-1980s. From 2000 to 2008, this borrowing averaged over $600 billion per year, which translates into U.S. spending exceeding income by almost 5.0 percent of GDP. Borrowing fell during the recent recession, as would be expected, and then rebounded with the recovery. Since 2011, however, borrowing has trended down and fell to 2.4 percent of GDP in 2013, the smallest amount as a share of GDP since 1997. A reduced dependency on foreign funds can be viewed as a favorable development to the extent that it reflects an improvement in the fiscal balance to a more easily sustainable level. However, it also reflects the lackluster recovery in residential investment, which is one reason the economy has yet to get back to its full operating potential.
The Bank of Japan announced an open-ended asset
purchase program in January 2013 and an unexpectedly ramped-up version of the
program was implemented in early April. Market
commentary at that time suggested that flooding the economy with liquidity
would lead to a “wall of money” flowing out of Japan in search of higher yields,
affecting asset prices worldwide. So far, however, Japan’s wall of money remains missing in action, with no pickup in
Japanese foreign investment since the April policy shift. Why is this? Here we
explain that while economic theory does not offer clear guidance on how
financial outflows might respond to the injection of cash from central bank
asset purchases, it does point to an important constraint on the potential size. In particular, monetary expansion will
not cause a surge in financial outflows unless it also induces a similar surge
in capital flowing into the country.
deficits in euro area periphery countries have now largely disappeared. This
represents a substantial adjustment. Only two years ago, deficits stood at nearly
10 percent of GDP in Greece and Portugal and 5 percent in Spain and Italy (see
chart below). This sharp narrowing means that spending has been brought in line
with income, largely righting an imbalance that had left these countries
dependent on heavy foreign borrowing. However, adjustment has come at a sizable
cost to growth, with lower domestic spending only partly offset by higher
export sales. Downward pressure on domestic spending should abate now that the
periphery countries have been weaned from foreign borrowing. The risk, though,
is that foreign creditors might demand that the countries pay down (rather than
merely service) accumulated external debts, forcing them to reduce spending
Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.
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The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.
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