THE U.S. CURRENT ACCOUNT: THE IMPACT OF HOUSEHOLD WEALTH

ABSTRACT Household wealth is shown to have a substantial impact on the current account through the wealth effect on savings. Private savings and wealth are estimated to share a negative relationship in the long run. Further, the impact of wealth changes on private savings takes several years, given an adjustment half-life of nearly 2 years. The reductions in private savings, due to changes in household wealth, reduce domestic savings. The increased inflow of foreign savings from the reduction in domestic savings is shown to have a negative effect on the current account balance. Two simulations demonstrate that small changes in the growth rate of wealth can have sizeable impacts on current account movements, altering the current account as a percent of GDP by as much as two percentage points. For the period 1998:Q3 through 2005:Q3, the difference in the actual and simulated current account deficit as a percent of GDP is 6.47 percent versus 8.83 percent, respectively. This difference is attributed to a difference between the actual growth rate of wealth over this period (0.82 percent) and the simulated growth rate (one percent). During the large increase in wealth, 1995:Q1 through 1999:Q4 (average actual wealth growth rate of 2.3 percent versus the simulated one percent growth rate), the actual current account deficit was 2.87 percent and the simulated deficit was 0.86 percent. Therefore, policies that impact wealth or saving can potentially affect the current account balance. INTRODUCTION AND LITERATURE REVIEW The current account deficit stood around 800 billion dollars, or approximately 6.5 percent of GDP, in 2005. "The United States current account records exports and imports of goods and services, unilateral transfers (gifts), U.S. earnings on investment abroad, and income payments to foreigners from their U.S. assets" (Humpage, 1998). But many analysts see the current account more broadly as the measure of international trade, because net exports contribute the largest portion. The current account has been steadily falling, creating a deficit, since an upswing in the early 1990's. This lasting current account deficit would seem to indicate that the United States has not exported enough to cover the amount of goods imported. A trade deficit is not an inherently bad thing, so the creation of such a large deficit would seem to speak of something more. It begs the question: is the lack of exports or the large amount of imports the only contributor to the current account deficit? One contributing factor to the large trade deficit may be the decreased private household savings relative to foreign savings, since the current account balance is the difference between domestic savings and domestic investment. "In the United States, national savings is currently quite low and falls considerably short of U.S. capital investment. Of necessity, this shortfall is made up by net foreign borrowing ... " (Bernanke, 2005). Therefore, the reduction in private savings, holding all else constant, leads to a decrease in the current account (an increase in the current account deficit). (1) The private savings rate is the amount of income left after households have paid their bills, as a percentage of income this savings rate declined until in January 2006 it reached 0.7 percent. Given the large current account deficit, a substantial increase in private savings is one means to reduce this imbalance (Lansing, 2005). Others look beyond the diminished savings rate into the calculation of private household savings. The reported private savings rate in the United States does not take into account increases in assets such as equities and homes (Marquis, 2002). Many see the increases in the value of these equities as a substitute for savings, i.e. the wealth effect. Marquis notes that one reason for the declining savings rate in the U.S. may be due to large increases in wealth. Lansing (2005) suggests that the decline in personal savings rates are attributed to the rising equity and housing prices. …