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External Adjustment and the Global Crisis


Philip R. Lane, IIIS, Trinity College Dublin and CEPR
Gian Maria Milesi-Ferretti, International Monetary Fund and CEPR


IIIS Discussion Paper No. 369


Abstract
The period preceding the global financial crisis was characterized by a substantial widening of current account imbalances across the world. Since the onset of the crisis, these imbalances have
contracted to a significant extent. In this paper, we analyze the ongoing process of external adjustment in advanced economies and emerging markets. We find that countries whose precrisis
current account balances were in excess of what could be explained by standard economic fundamentals have experienced the largest contractions in their external balance. We subsequently examine the contributions of real exchange rates, domestic demand and domestic output to the adjustment process (allowing for differences across exchange rate regimes) and find that external adjustment in deficit countries was achieved primarily through demand compression, rather than expenditure switching. Finally, we show that other investment flows was the main adjustment category in the financial account but that ECB liquidity and official external assistance have cushioned the exit of private capital flows for some countries.


Keywords: global crisis, current account adjustment.
JEL Classification: F31, F32


Last updated 28 August 2014 by IIIS (Email).