Unraveling the cobweb of global imbalances: drivers, vulnerabilities, and adjustment scenarios

Focus

The stock of global imbalances has recently increased sharply, with the US net international investment position (NIIP) deteriorating while the NIIP has improved in most other major economies. This has raised concerns about potential macroeconomic and financial vulnerabilities and brought global imbalances to the forefront of the international economic policy agenda. Evaluating different proposals and risks requires unravelling the cobweb of international financial exposures behind these imbalances. 

Contribution

We analyse the evolution and drivers of global imbalances, diagnose the associated vulnerabilities and examine potential adjustment scenarios. We evaluate a sample of 28 economies, which account for about 85% of global GDP. To assess the risks associated with the current elevated levels of global imbalances and various adjustment scenarios, we simulate the effects of several potential triggers: a sharp dollar depreciation, a repricing of global equity markets, an increase in global interest rates and a halving of trade imbalances.

Findings

Financial factors (including valuation changes and investment income flows) are the primary drivers of global imbalances at both short and long horizons, while trade also plays a significant role (especially at long horizons). Since 2010, valuation gains on international investment positions have supported economic growth in many countries but also made those countries more vulnerable to adjustments in financial markets. Our simulation exercises highlight the challenges in reducing today’s large global imbalances, and suggest that if current trends continue, imbalances will continue widening. Popular policy proposals are estimated to have limited effects, and any sizeable reduction in imbalances would trigger substantial international spillovers. The scenarios also highlight which countries would be more (negatively or positively) affected via different rebalancing mechanisms, including the large, negative effects for most countries stemming from any correction in US equity markets. The persistence of global imbalances underscores the importance of building resilience to the large negative spillovers that can occur suddenly through this cobweb of international exposures.

Abstract

This paper analyses the evolution and drivers of the stock of global imbalances in order to assess associated vulnerabilities and potential adjustment scenarios. These imbalances have recently increased sharply, with a deterioration in the US net international investment position (NIIP) mirrored by NIIP improvements in most other major economies. We decompose these NIIP changes into their proximate drivers for a sample of 28 economies and find that financial factors (including valuation changes and investment income flows) are the primary drivers of global imbalances at both short and long horizons, while trade also plays a significant role (especially at long horizons). Valuation gains on international investment positions have supported economic growth in many countries since 2010, while also increasing their vulnerability to financial market adjustments. To assess the implications and potential risks, we simulate the spillovers through this cobweb of global imbalances from: (i) a sharp dollar depreciation, (ii) a repricing of equity markets, (iii) higher interest rates, and (iv) a halving of trade imbalances. These scenarios highlight the large international spillovers that would be associated with any reduction in global imbalances, the heterogeneous impact of various rebalancing mechanisms on individual countries and the limits of popular proposals for reducing these imbalances. The persistence of global imbalances underscores the importance of building resilience to the large spillovers that can occur through this cobweb of international exposures.