Small and Large Economies
6.5 The Global Saving Glut Hypothesis
Between 1995 and 2005, the U.S. current account deficit experienced a dra-matic increase from $125 to $ 623 billion dollars. This $500 billion dollar increase brought the deficit from a relatively modest level of 1.5 percent of GDP in 1995 to close to 6 percent of GDP in 2005. With the onset of the great recession of 2007, the ballooning of the current account deficits came to an abrupt stop. By 2009, the current account deficit had shrunk back to 3 percent of GDP. (See figure 6.9.)
An important question is what factors are responsible for these large swings in the U.S. current account. In particular, we wish to know whether the recent rise and fall in the current account deficit were driven by domestic or external factors.
Figure 6.9: The U.S. Current Account Balance: 1960-2012
1960 1970 1980 1990 2000 2010
−1000
1960 1970 1980 1990 2000 2010
−6
Data Source: BEA. The vertical lines indicate the years 1996 and 2005.
6.5.1 The Period 1996 to 2006
In 2005 Ben Bernanke, then a governor of the Federal Reserve, gave a speech in which he argued that the deterioration in the U.S. current account deficits between 1996 and 2004 were caused by external factors.2 He coined the term ‘global saving glut’ to refer to these external factors. In particular, Bernanke argued that the rest of the world experienced a heightened desire to save but did not have incentives to increase domestic capital formation in a commensurate way. As a result, the current account surpluses of the rest of the world had to be absorbed by current account deficits in the United States.
Much of the increase in the desired current account surpluses in the rest of the world during this period originated in higher desired savings in emerg-ing market economies. In particular, Bernanke attributes the increase in the desire to save to two factors: (1) Increased foreign reserve accumulation to
2Bernanke, Ben S., “The Global Saving Glut and the U.S. Current Account Deficit,”
Homer Jones Lecture, St. Louis, Missouri, April 14, 2005.
International Macroeconomics, Chapter 6 161
Figure 6.10: U.S. Current Account Deterioration: Global Saving Glut or
“Made in the U.S.A.”
avoid or be better prepared to face future external crises of the type that had afflicted emerging countries in the 1990s. And (2) Currency depreciations aimed at promoting export-led growth.
The global saving glut hypothesis was unconventional at the time. The more standard view was that the large U.S. current account deficits were the results of economic developments inside the United States and unrelated to external factors. Bernanke refers to this alternative hypothesis as the “Made in the U.S.A.” view.
How can we tell which view is right, the global saving glut hypothesis or the “Made in the U.S.A.” hypothesis? To address this question, we can use the graphical tools developed in section 6.4 of this chapter. The left panel of figure 6.10 illustrates the effect of a desired increase in savings in the rest of the world. The initial position of the economy, point A, is at the intersection of the CAU S and CARW schedules. In the initial equilibrium, the U.S. current account equals CAU S0 and the world interest rate equals
r∗0. The increase in the desired savings of the rest of the world shifts the current account schedule of the rest of the world down and to the left as depicted by the schedule CARW 0. The new equilibrium, point B, features a deterioration in the current account deficit of the U.S. from CAU S0 to CAU S1 and a fall in the world interest rate from r∗0 to r∗1. Intuitively, the United States will borrow more from the rest of the world only if it becomes cheaper to do so, that is, only if the interest rate falls. This prediction of the model implies that if the global saving glut hypothesis is valid, then we should have observed a decline in the interest rate.
The “Made in the U.S.A.” hypothesis is illustrated in the right hand panel of figure 6.10. Again, in the initial equilibrium, point A, the U.S.
current account equals CAU S0 and the world interest rate equals r∗0. Under this view, the current account schedule of the rest of the world is unchanged and instead the current account schedule of the United States shifts to the left as depicted by the schedule CAU S0. The new equilibrium, point B, features a deterioration in the current account deficit of the U.S. from CAU S0 to CAU S1 and a rise in the world interest rate form r∗0to r∗1 > r∗0. Both hypotheses can explain a deterioration in the U.S. current account. However, the global saving glut hypothesis implies that the CA deterioration should have been accompanied by a decline in world interest rates, whereas the
“Made in the U.S.A.” hypothesis implies that world interest rates should have gone up. Hence we can use data on the behavior of interest rates to find out which hypothesis is right.
Figure6.11plots the world interest rate.3 It shows that over the period
3The world interest rate is computed as the difference between the 10-year constant
International Macroeconomics, Chapter 6 163
Figure 6.11: The World Interest Rate: 1992-2012
1995 2000 2005 2010
−1 0 1 2 3 4
Year
Percent per year
Note. The world interest rate is approximated by the difference between the rate on 10-year U.S. Treasury securities and expected inflation. The vertical lines indicate the years 1996 and 2005, respectively.
in question, 1996 to 2005, interest rates fell, validating the global saving glut hypothesis and rejecting the “Made in the U.S.A.” hypothesis.
6.5.2 The Period 2006 to 2012
Can the global saving glut hypothesis also explain changes in U.S. current account dynamics after 2005? Figure6.9shows that at its peak in 2006 the U.S. current account deficit had reached 6 percent of GDP. Over the follow-ing 3 years, the deficit was reduced to half, or 3 percent of GDP. Under the global saving glut hypothesis, this reduction in the current account deficit would be attributed to a decline in desired savings in the rest of the world.
Again we can use the graphical tools developed earlier in this chapter to evaluate the plausibility of this view. Consider the left panel of figure6.10.
Assume that the initial equilibrium is at point B, where the world interest rate is equal to r∗1 and the U.S. current account deficit is equal to CAU S1. We can represent a decline in desired savings in the rest of the world as a shift up and to the right in the current account schedule of the rest of the world. For simplicity, assume that this adjustment is shown as a return of the current account schedule of the rest of the world back to its original po-sition given by CARW so that the new equilibrium is given by point A. This shift in the current account schedule of the rest of the world causes the U.S.
current account to improve from CAU S1 to CAU S0 and the interest rate to rise from r∗1to r∗0. It follows that under the global saving glut hypothesis, the V-shape of the U.S. current account balance observed between 1996 and
maturity Treasury rate and expected inflation. Expected inflation in turn is measured as the median CPI-inflation forecast over the next 10 years and is taken from the Survey of Professional Forecasters.
International Macroeconomics, Chapter 6 165 2009 (see figure6.9), should have been accompanied by a V-shaped pattern of the interest rate. However, figure 6.11 shows that the interest rate does not display a V-shaped pattern as predicted by the global saving glut hy-pothesis. In fact, since 2005 the interest rate has declined further rejecting the global saving glut hypothesis as an explanation of U.S. current account dynamics since 2005.
We conclude that the global saving glut hypothesis presents a plausible explanation for the observed developments in the U.S. current account deficit over the period 1996-2005. At the same time, the empirical evidence, in particular, the behavior of interest rates, suggests that the dynamics of the U.S. current account since 2005 were not primarily driven by external factors, but instead by domestic disturbances.