Macroeconomic Policy Making, Exchange Rate Adjustment and Current Account Imbalances in Emerging Markets

• Author: Gunther Schnabl,Pablo Duarte
• DOI: http://doi.org/10.1111/rode.12168
• Published date: 01 August 2015
• Date: 01 August 2015

Macroeconomic Policy Making, Exchange Rate

Adjustment and Current Account Imbalances in

Emerging Markets

Pablo Duarte and Gunther Schnabl*

Abstract

Given a series of crisis events after 2007 the discussion about the adjustment channels of current account

imbalances has been revived. We examine the role of exchange rates vs macroeconomic policies as deter-

minants of current accounts for a set of 86 mainly emerging market economies between 1990 and 2013 to

identify adjustment channels for global imbalances. We find that nominal exchange rates are not the main

determinant of current account positions. Instead, depending on the region, monetary and/or fiscal policies

are identified as the main driving force of current accounts. For East Asia and the oil exporting countries

sterilization policies, i.e. relatively tight monetary policies, are the main determinants. In contrast for many

European periphery countries fiscal policy stances are at the core of current account positions. Only for the

Latin American countries does the exchange rate play a significant role as determinant of current account

positions.

1. Introduction

Despite a major contraction in the wake of the US subprime crisis and the European

debt crisis global current account imbalances persist, in particular outside Europe,

and contribute to a further widening of the stock of global imbalances in the form of

diverging net foreign asset positions (Lane and Milesi-Ferretti, 2014). Whereas dire

adjustment programs within the European (Monetary) Union have mainly eliminated

crisis-prone current account deficits, the current account positions have remained an

economic policy concern. This has been the case in particular for a set of emerging

market economies such as Brazil or Turkey, because their current accounts constitute

the breeding ground for (potential) balance of payments and foreign debt crisis owing

to risky foreign exchange exposure. Also the current account surpluses in East Asia,

particularly China, continue to be the origin of trade conflicts and concerns about cur-

rency wars.

The persistence of transpacific global imbalances, in particular between the USA

and the East Asian and the oil exporting countries, as well as the strengthening of

trans-Atlantic current account imbalances between Germany (and some smaller

northern European countries) and the USA (Figure 1) has revived the discussion

about the determinants and adjustment channels of global current account imbal-

ances. In this context, in the spirit of Friedman (1953), exchange rate flexibility is per-

ceived to play a pivotal role for current account adjustment. Furthermore as shown in

Europe, curtailing public deficits has been at the core of policy measures to reduce

current account deficits.

* Schnabl: University of Leipzig, Institute for Economic Policy, Grimmaische Straße 12, 04109 Leipzig,

Germany. Tel: +49-(0)341-9733561; E-mail: schnabl@wifa.uni-leipzig.de. Duarte: University of Leipzig,

Institute for Economic Policy, Leipzig, Germany. The authors thank Stefan Angrick, Talina Sondershaus

and Taiki Murai for their research assistance.

Review of Development Economics, 19(3), 531–544, 2015

DOI:10.1111/rode.12168

© 2015 John Wiley & Sons Ltd