##erabilities. in this case, banks became dependent on shortterm funding from overseas, rather than their traditional domestic deposit base. when investors re - trenched, that funding dried up and banks struggled to find viable alternative sources of funding. ensuring gross capital flows are not excessive is just as important as avoiding excessive net capital flows. moving to a sustainable equilibrium requires a narrowing in the international payments imbalances. and we have indeed seen such a narrowing since the start of the crisis. for instance, the international monetary fund ( imf ) expects a current account deficit in the united states of just under 3 % of gdp this year, while the chinese surplus is expected to have fallen to around 2½ % of gdp. but, as with the euro area, the crucial question is how much of this narrowing is simply a reflection of the cyclical weakness in the deficit economies or whether it represents a more durable shift in the pattern of demand in both deficit and surplus economies. if it is down to the former, then the imbalances can be expected to reemerge as recovery proceeds. the answer to this question depends very much on the degree to which the substantial shortfall, relative to pre - crisis trends, of activity in the deficit economies represents a permanent impairment of supply potential as a result of the financial crisis and subsequent recession, or whether it will ultimately be reversed. successive inflation reports and speeches by several mpc members 6 have addressed this issue in the context of the united kingdom, and i think it is fair to say that the evidence is presently inconclusive. chart 11 provides an assessment, drawing on imf analysis, of the evolution of structural deficits and surpluses for two alternative scenarios, with the red dashed line corresponding to an assumption that supply impairment in the advanced economies as a result of the crisis is minimal ( and therefore output gaps are correspondingly large ), whereas the blue dashed line – which corresponds to the imf ’ s central case – assumes a relatively high degree of supply impairment ( and therefore substantially smaller output gaps ). in the former case, the bulk of the post - crisis narrowing in imbalances is attributed to cyclical factors, whereas in the latter they are attributed to structural factors. clearly, depending how one reads the data, one can arrive at a different conclusion. an alternative way into this is to look at what has happened to relative prices, rather than quantities. a natural counterpart of a rotation in demand from the advanced to the emerging world should be

a fall in the real exchange rates of the former and a rise in those of the latter. by increasing the profitability in deficit countries of producing internationally tradable goods and services relative to that of non - tradables, that should facilitate the necessary shift of resources between sectors. the opposite is true for the emerging economies. chart 12 shows such a shift has taken place since before the crisis, with both sterling and the dollar depreciating in real terms, and the renminbi appreciating. so there is evidence that at least some of the necessary structural adjustment has taken place, though in all likelihood it still has further to run. what sorts of policies would facilitate the required adjustment without relying on sustained weakness in the indebted countries? at pittsburgh, in 2009, the g20 identified five ingredients. first, surplus countries should take steps to boost domestic demand. second, deficit countries should implement credible strategies to support private savings and restore fiscal sustainability. third, exchange rates need to be allowed to reflect underlying see for instance : broadbent ( 2012 ), miles ( 2012 ) and dale ( 2013 ). bis central bankers ’ speeches fundamentals. fourth, financial regulation and supervision should be strengthened to prevent the re - emergence of financial sector excesses. fifth, structural reforms should be pursued, not only to boost long - term growth but also potentially to boost demand in the short run. this sounds straightforward, but why has it in practice proved so difficult to achieve? first and foremost, the actors have not always shared the same diagnosis of the underlying problems. second, in circumstances like the present, when there is still a significant margin of spare capacity in many economies, an expansion in activity in one country generates beneficial spillovers onto other countries ( the opposite would be the case if there was excess demand and overheating ). but policy makers typically do not take account of these spillovers when judging how much to stimulate their economies. consequently uncoordinated decision - making can lead to inefficiently low demand. moreover, the space for policy action in the deficit countries is in most cases circumscribed, placing more of the onus on the surplus countries that have more room for manoeuvre. now, in principle, coordination could generate a better outcome by helping policymakers to internalise the consequences of their actions. and that is indeed what the g20 framework for strong, sustainable and balanced growth set out to achieve. but implementing