Current-account rebalancing and international transfers (immaculate or not)

Giancarlo Corsetti, Philippe Martin, Paolo Pesenti, 31 January 2013



Current-account imbalances in Europe are at the heart of the crisis, and rebalancing must therefore be part of the crisis resolution. How will this rebalancing take place? The view of many observers is that, given that it is difficult to envisage large changes in real exchange rates in the Eurozone, the outlook looks bleak. In the absence of large real exchange-rate depreciation, the argument goes, the European periphery faces the prospect of adjustment via an unsustainable collapse of domestic demand rather than through a desirable increase in production and exports.
We disagree. We believe that European rebalancing could proceed along a different (perhaps less socially costly) path. Along this alternative path, net creation of new varieties of tradables plays a more conspicuous role, alongside some (not necessarily dramatic) real exchange-rate depreciation.

How large should the real exchange-rate adjustment in Europe be?

As stressed by Obstfeld, Rogoff and Krugman in several contributions, one needs to go back to the classics. The European rebalancing problem can and should be addressed from the vantage point of the ‘transfer problem’ controversy that was initiated by Keynes and Ohlin in the context of German reparations after the first world war, a problem still lively debated in the profession. In a nutshell:

  • International adjustment requires a transfer of real resources from the debtor countries running current-account deficits to the creditor countries running surpluses;
  • To generate the required amount of resources to be transferred abroad, a deficit country needs a contraction in its domestic demand.

Keynes stressed that such contraction falls disproportionally on domestically produced goods, causing a decline in their relative price, thus real depreciation. While ‘gaining competitiveness’, the deficit country experiences a much heavier adjustment, due to the adverse movements of its terms of trade.

Against Keynes, Bertil Ohlin, the Swedish economist, de-emphasised the role of movements in relative prices, arguing that the reallocation in world demand as a result of the international transfer would lean against real depreciation in the rebalancing country, or even make it redundant. 

Reconsidering Keynes’ argument in the context of the US current-account rebalancing, Maury Obstfeld and Ken Rogoff (2005, 2007) estimated the size of relative price adjustment required to unwind the US deficit to be so large to motivate warnings about the potential collapse of the dollar. The opposing view, that rebalancing may bring about only modest movements in real exchange rates, is often rather quickly dismissed as a “doctrine of immaculate transfers”. The debate about the ‘competitiveness’ of countries such as Italy or Spain, not to mention Greece, follows the same pattern. 

Another mechanism

However, there is a mechanism of adjustment which is overlooked in the original ‘transfer controversy’ – the so-called extensive margin of trade. We argue that it may play a key role in rebalancing among industrial countries over a medium-term horizon (Corsetti , Martin and Pesenti 2013).

By shifting demand from the deficit to the surplus country, a transfer causes profits to fall in sectors servicing the domestic market under contraction, but to increase in sectors oriented toward the other market. Via a shift in market size and profitability, a transfer changes the incentives of domestic and foreign firms to enter and exit these markets: in the deficit country, firms exit the nontradables sector while entering tradable (and exportable) goods sectors; in the foreign country, the export sector contracts. This effect of a transfer is exactly what Paul Krugman (1980) dubs the “home market effect".

To put it differently, over the medium-term adjustment can occur both along the extensive margin – entry and exit of goods and firms – and the intensive margin – rise in the volume of trade in existing goods and firms. Traditional ‘transfer-problem’ analyses only consider the latter, and thus tend to overestimate the role of international prices. In contrast, simulations of our model suggest that even a significant international transfer – of the size of the pre-crisis current-account deficit in the US or in the periphery of Europe – may require only a moderate trend depreciation, in real terms. By way of example, closing a current-account deficit as high as 6.5% of GDP is associated with a real depreciation between 8.3 and 13.5%. As adjustment occurs at the extensive and intensive margins, a large real exchange depreciation is neither a sufficient nor a necessary condition for resolving global and regional imbalances.

The stylised facts on recent episodes of trade and current-account adjustment in industrialized countries indeed lend support to a balanced view on the controversy. First of all, there is pervasive evidence that a significant fraction of trade adjustment across sectors and borders occurs at the extensive margin. For around 80% of countries, over 40% of all goods categories exported to the US in 1998-2000 were in newly traded goods, that is, goods that were not exported in 1989-91 (Debaere and Mostashari, 2010). Evidence discussed in an IMF report suggests that economies with lower costs of starting and closing a firm, and of hiring and firing labour, have experienced smaller movements in real effective exchange rates during external adjustment episodes (2007).

Second, according to a large body of evidence, the resolution of large deficits does not seem to require an extensive depreciation, nor is it likely to be associated with an exchange rate crisis. Focusing on the US, the real exchange rate has been a relatively minor driver of past current-account developments, accounting for only about 7% of the movements of the US trade balance at a horizon of 20 quarters (Fratzscher, Juvenaly and Sarno 2010).

Addressing intra-European imbalances, the conventional therapy for the structural ills of the countries in the European periphery prescribes real depreciations – possibly fostered by policies accelerating large-scale wage and price disinflations – with the goal of regaining cost competitiveness and closing trade gaps. Brought to its extreme consequences this view often translates into the claim that, for the crisis countries, there may be no alternative to abandoning the Eurozone, and adjusting relative prices via large nominal depreciations.

In contrast, our model suggests that European rebalancing could proceed along a different path, along which what matters is the country’s ability to be a net creator of new varieties of tradables.

Policy implications

To foster adjustment, policy should target obstacles to firms' entry, startup costs, and the incentives for product differentiation. This would let relative prices and wages adjust in equilibrium. Setting up firms and new production lines is costly and typically requires financial resources: in the current circumstances, policy should also address tight credit constraints on investment and firms’ activity due to liquidity and balance sheet problems hitting banks.

Are we taking side with the believers in the ‘immaculate transfers’, underwriting Ohlin’s criticism of Keynes’ views? Not quite. The Keynesian point that a transfer has high macroeconomic costs is very much alive in our story, even though the logic and mechanism of adjustment differ substantially from Keynes’. In the traditional model, deficit countries suffer a welfare loss because of adverse movements in the terms of trade. In our story, welfare losses stem from a reduced range of consumption varieties (both imported and domestically produced) in the domestic market (a point emphasised by Christian Broda and David Weinstein (2004, 2006). Large currency fluctuations, much emphasised in the traditional literature on current-account rebalancing, may end up being a very inadequate measure of the social costs associated with the adjustment process.

Of course, our story does not deny that some real depreciation may be needed to somewhat facilitate the adjustment process. But the main message is that relative price adjustment need not be as dramatic as some observers claim is unavoidable. What may matter, at least as much, are policies focusing on market liberalisation and reduction of inefficient barriers to entry.


Broda, C and D Weinstein (2004), "Variety Growth and World Welfare", The American Economic Review Papers and Proceedings, 94(2), 139-144.

Broda, C, and D Weinstein (2006), "Globalization and the Gains from Variety", Quarterly Journal of Economics, 21(2), 541-85.

Corsetti, G, P Martin and P Pesenti (2013), "Varieties and the Transfer Problem", Journal of International Economics 89(1), January, 1-12.

Debaere, P, and S Mostashari (2010), "Do Tariffs Matter for the Extensive Margin of International Trade? An Empirical Analysis", Journal of International Economics, 81(2), 163-169.

Fratzscher M, L Juvenaly and L Sarno (2010), "Asset Prices, Exchange Rates and the Current Account", European Economic Review, 54(5), 643-658.

International Monetary Fund (2007), World Economic Outlook: Spillovers and Cycles in the Global Economy, 103-104, Washington, DC, International Monetary Fund, April.

Krugman, P (1980), "Scale Economies, Product Differentiation, and the Pattern of Trade", The American Economic Review 70, 950-959.

Obstfeld, M, and K Rogoff (2005), "Global Current Account Imbalances and Exchange Rate Adjustments", Brookings Papers on Economic Activity, 1, 67-123.

Obstfeld, M, and K Rogoff (2007), "The Unsustainable US Current Account Position Revisited", in R Clarida (ed.) G7 Current Account Imbalances: Sustainability and Adjustment, Chicago, IL, University of Chicago Press, 339-376.

Topics: Europe's nations and regions
Tags: current-account imbalances, Eurozone crisis, rebalancing

Giancarlo Corsetti

Professor of Macroeconomics, University of Cambridge and Programme Director, CEPR

Professor of Economics at Sciences Po (Paris) and CEPR Research Fellow

Vice President and Monetary Policy Advisor, Federal Reserve Bank of New York