Greenspan on the Current Account Deficit

Greenspan gave a speech earlier today in which he talked about the US current account deficit. Shorter Greenspan:

  • The ability of the US to keep running a huge and growing CA deficit is the result of a decrease in home bias. In other words, investors around the world are more willing to stash their savings in other countries (e.g. the US) than they used to be, which means that US borrowers have easier access to foreign loans than they used to.
  • There’s not much that policy-makers can do about it. Interest rate and exchange rate management would have limited effects, as would deficit-reduction efforts.
  • The US CA deficit can’t keep growing forever. Sooner or later it’s going to stop growing, and interest rates in the US will rise.
  • However, the adjustment can probably still be smooth for the US, due to “the flexibility of our market-driven economy.” So there’s no need to worry, unless policy-makers start mucking about with the natural workings of the market.

These are familiar themes from earlier comments by Greenspan about the CA deficit. I was most disappointed about this line in his speech, however: “a discretionary reduction in our federal budget deficit would work toward narrowing the current account deficit but, if history is any judge, to an uncertain and possibly small extent.”

This downplaying of the importance of reducing the budget deficit strikes me as almost irresponsible from a central banker. The speech was a perfect chance for Greenspan to talk about the dangers inherent in the large and sustained structural budget deficit in the US. While it is true that reducing the budget deficit would cause only a “possibly small” improvement in the US CA imbalance, it is also true that the effect could be possibly quite large (econometric studies disagree substantially about that point). Regardless, any central banker of a country with the terrible budget problems of the US has a responsibility to clearly point out that budget problems and CA problems are often closely related, and that anything that can be done to alleviate the US’s CA problem will help to make the coming adjustment less painful.

Otherwise, the speech contained nothing striking. Perhaps this speech contained a slightly more direct statement of the obvious, which is that the US CA deficit must start falling at some point. But he was typically sanguine about that prospect. Of course, like the rest of us, Greenspan has no idea when or how things will really transpire…