Global imbalances and the current account deficits and surpluses they create have been a topic of debate over the past few years. Some have argued that they were a key factor in causing the financial crisis, believing that emerging market's excess savings and lack of investment improved financial conditions in those advanced economies running current account deficits and lowered world interest rates. This inflow of saving contributed to create a boost in not only credit but also risk-taking in advanced economies such as the United States of America, which led to such events as the housing market collapse and started the chain of events for the financial crisis. For this excess savings hypothesis to run true, it would mean that the capital flows from the countries running a current account surplus to those in deficit financed the pre-financial crisis boom in the deficit countries and also the increase in the ratio of ex ante global savings to investment in the countries with a current account surplus lowered world interest rates.
Global imbalances can be defined as "External positions of systemically important economies that reflect distortions or entail risks for the global economy". (Bracke et al. 2008). To fully understand this we need to break down this definition, firstly external positions encompass financial positions and current account balances and secondly the "systemically important economies" are those where economy decisions and status can have serious implications on the global economy. The distortions that the quote refers to are divergences in the equilibrium that would occur in a flexible and perfectly competitive market. The risks these imbalances pose to the global economy could be if these imbalances were to unwind, causing disruptions to stability and also if these imbalances were to increase, as Bracke fears the "risk of a protectionist backlash". (Bracke et al., 2008).
The introduction of international trade brought about the existence of global imbalances. Countries with high potential for production who export to countries with less production increase their current account balances, whereas countries that have a higher tendency to import goods are more likely to hold deficits in their current account. At the start of the twentieth century countries such as Great Britain and France had surpluses in their current account but due to the increase in foreign trade over this time these countries have increased their imports due to other countries having higher comparative advantages in trade against them, it has meant that it has been cheaper to source goods from overseas where the labour and production costs are lower. This has meant that these countries are now in the positions of holding current account deficits. The United States of America has gone from being the world's largest creditor to a debtor. This was partially due to the increased flow of investments into the country, tax cuts, the oil crisis in the 1970's, but also due to the increased importance of international trade, meaning it is cheaper for companies to outsource a lot of their production to developing countries such as those in South America and Asia. During the 2000's it has increasingly been these developing countries that have held current account surpluses whilst the advanced countries' account deficits seem to be increasing. The economic crisis and subsequent recovery in Southeast Asia meant that their new policies of increasing their exports led to economic growth in these countries and also current account surpluses.
Blanchard and Milesi-Ferretti (2009) argue that in an economy with international trade there is no reasons for balanced current accounts to be necessary, infact the opposite of this is attractive, it is better for investments to go where they will have the greatest effect and therefore imbalances will emerge due to certain economies having a greater attraction for savings due to their possibilities for production. Due to imbalances being very common it is important that we can distinguish between good and bad imbalances, as bad imbalances can create distortions and risks in the market. There are many causes of these global imbalances, one being increase of the fiscal deficit which brings in "twin deficit" hypothesis, which is when the current account balance is equal to saving minus investment, so an increase in fiscal deficit and reduces savings will in turn increase the current account deficit. An increase in public spending will also increase interest rates, attracting foreign investment and therefore strengthening the currency, increasing these imbalances even further.
Private spending can also have an impact on the current account deficit, the United States personal saving rate has reduced in recent years to around 2% of disposable income (Gruber and Kamin 2006)
