Imbalances over the Pacific

This paper examines various theories of current account (trade) imbalances between the U.S. and China, by estimating a structural VAR model with long-run zero restrictions. The factors that we examine include: productivity differential, fiscal policy, consumption/saving choice, and real and nominal demand side factors comprising monetary policy, and reserve accumulation. On average, technology shocks are found to play a dominant role in explaining the trade balance movement between China and the U.S. However, in the particular period of 2004-07 when global imbalances peaked, we find that demand shocks played an unusually large role. This contrast between the average tendency and the rather abnormal development in the mid-2000s provides general equilibrium evidence for several theories of current account (trade) balance imbalance. But it also shows that the experience of the mid-2000s does not have to repeat itself, given that it was an atypical development different from the average tendency.