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Economic Brief

October 2017, EB17-10

Should We Worry about Trade Imbalances?
By Thomas A. Lubik and Tim Sablik

Trade imbalances are a perennial concern for policymakers and the public.
But what does it mean for a country to have a trade surplus or deficit? The
United States has run persistent trade deficits since the late 1970s, while
Germany has had trade surpluses since the 1990s. Is either position inherently good or bad? The answer to this fundamental question of economic
policy is a resounding “no” — up to a point.
Trade imbalances have been the focus of recent
policy discussions in a number of countries. For
example, the United States has run persistent
trade deficits since the late 1970s, while Germany has had trade surpluses since the 1990s.
(See Figure 1.) In order to understand how such
imbalances might matter, or not, for economic
policy, it is useful to consider a closely related
concept: the current account.
The current account measures the value of a
country’s net exchange of goods and services
with the rest of the world. It also includes any
income earned on capital invested abroad and
net transfers of cash to other countries (typically
in the form of foreign aid). For most countries,
the balance of trade makes up the lion’s share of
the current account, and the two tend to move
in tandem.
Because a country’s current account balance is
largely determined by trade flows, one might
assume that whether it is in surplus or in deficit
largely depends upon other countries. In fact,
the current account reflects domestic saving
and investment decisions. To see why, consider

EB17-10 - Federal Reserve Bank of Richmond

the national income identity, an accounting
concept that equates gross domestic product
(GDP) to the sum of consumption, investment,
government spending, and net exports. According to this identity, the net exports component
equals domestic production minus consumption, government spending, and investment.
National saving can be thought of as the difference between production and private and
public consumption. Thus, the current account
is roughly equal to the difference between saving and investment. From an accounting standpoint, then, a current account surplus simply
means that a country’s savings exceed its investments, and vice versa for a current account
deficit. This relationship holds as an identity and
at the same time provides insight into the current account’s determinants.
But this accounting identity does not shed any
light on whether current account deficits and
surpluses are “good” or “bad” from the perspective of domestic or international economic policy.
In order to determine that, one needs to consider
the factors that drive domestic saving and investment over time. This Economic Brief will explore

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these factors through the examples of the United
States, which has a current account deficit, and Germany, which has a current account surplus.
What Drives National Saving and Investment?
At the individual level, saving reflects a desire to put
money aside for the future. National saving reflects
the same desire on an aggregate level. A country can
put national aggregate savings aside either domestically or abroad. If the country has a current account
surplus, it is setting money aside abroad.
Other things being equal, a country with a current
account surplus has extra savings that the domestic
economy does not need or cannot absorb. This can
be explained by a high private sector saving rate,
by government budget surpluses, or by an underdeveloped domestic financial system. All of these
elements are arguably the case for Germany (see
Figure 2), whereas the opposite holds true for the
United States. Current account surpluses and deficits
therefore reflect these underlying factors and their

Figure 1: Balance of Trade (in Goods)

potential imbalances. As far as policy is concerned,
the current account is a symptom, not a cause.
Another way to see this is on the flip side of the current account, which is called the capital account. A
country with a current account surplus exports goods
and services to other countries and receives payment
in their currency. Generally, the exporting country
reinvests that currency either directly (building factories in the other country, for example) or indirectly
by purchasing financial assets (stocks and bonds)
from the other nation. These components, along with
foreign cash reserves and asset holdings, make up the
capital account. The current account and capital account comprise a country’s balance of payments and
must sum to zero. So a country with a current account
surplus has a capital account deficit, since it is importing more foreign stocks and bonds than it is exporting. In this way, it is “exporting” its savings.1 These
foreign savings can deliver returns in the future. At
the level of a country, a current account surplus can
therefore reflect a desire to prepare for the future.

Balance of Trade (in Goods)


of Dollars













Sources: U.S. Census Bureau, Deutsche Bundesbank, and Haver Analytics
Note: Shaded areas indicate U.S. recessions.

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However, having a current account surplus or a
capital account deficit does not necessarily mean a
country has high savings. The second component of
the current account is domestic investment. Other
things being equal, a country tends to run a current
account surplus if its domestic investment rate is low
and a deficit if its domestic investment rate is high.
The latter case can come about if a country has more
investment opportunities than its domestic savers
can finance. This imbalance also can be seen from
the perspective of a country’s capital account. Since
the U.S. financial system is highly sophisticated, large,
and liquid, it attracts more funds than it exports.
Because the balance of payments must net to zero,
the resulting capital account surplus has to be
matched by a current account deficit. The attractiveness of the United States as an investment destination therefore helps drive its current account deficit.
(See Figure 3.)2
Saving for the Future (the German Case)
A country with a current account surplus today can
expect payments in the future from those surplus

savings. In effect, the country is choosing to save today to spend more tomorrow. Why might it do this?
A country’s saving and spending decisions simply reflect the aggregate decisions of its residents. Individuals must decide how much to save and how much
to consume over their lifetimes. In general, working
individuals will save to preserve their standard of living in retirement (a pattern of behavior described by
the life cycle hypothesis). And if they believe conditions in the future will be worse than the present,
they will save even more today.
There are a number of factors that might lead a
country’s residents to be pessimistic about their
economic futures. First, they may simply be extrapolating from a dismal past. In the 1990s and early
2000s, Germany was known as the “sick man of
Europe.” The fall of the Berlin Wall and the reunification of East Germany and West Germany imposed
significant economic costs. From 1998 through 2005,
Germany’s annual economic growth averaged only
1.2 percent. To be sure, Germany has fared significantly better since that period. Labor market

Domestic Saving
Figure 2: German Domestic Saving
and Investment

and Investment


Billions of Euros












Sources: Deutsche Bundesbank, Statistisches Bundesamt, and Haver Analytics

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reforms in the mid-2000s and rising demand for
German luxury goods and precision manufacturing (particularly from China) have helped turn the
country into the economic powerhouse of Europe.3
But recent memories of less prosperous times still
may be influencing Germans’ expectations of the
future. If they believe the good times are only transitory, they still may save more for the future than
would otherwise be expected.
Other factors that can influence a country’s outlook
on future growth include trends in demographics
and productivity. As is the case in many advanced
countries, Germany’s population is aging. According
to the U.S. Census Bureau’s international database,
one in four Germans are projected to be over the age
of sixty-five by 2025. Older populations work less,
reducing a country’s potential productivity and GDP
growth. Indeed, concerns about slower productivity growth are widespread in the developed world.
Some economists have argued that the productivity
gains of the twentieth century will not be replicated

in the twenty-first and that average growth will be
much slower in the future.4 This, too, could be a reason for relative pessimism and higher savings.
Another factor that may influence a country’s expectations for the future is its dependence on natural
resources for economic growth. If residents expect to
exhaust those resources in the near future, and there
is no alternative source of growth, they might save
for expected slower growth in the future. Norway is
a good example. Its government uses proceeds from
its oil reserves to finance a national pension fund to
maintain consumption levels after its oil runs out.
All of these factors can help explain why countries
run current account surpluses. But is a current account surplus necessarily a cause for concern? One
could argue that a current account surplus might be
a symptom of underinvestment in infrastructure necessary to promote future growth. So countries with
high savings rates due to their relatively pessimistic
outlooks of the future should do more to increase

Domestic Saving
Figure 3: U.S. Domestic Saving andU.S.

and Investment


of Dollars













Sources: U.S. Bureau of Economic Analysis and Haver Analytics
Note: Shaded areas indicate U.S. recessions.

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investment in infrastructure to boost future growth,
even potentially to the point of temporary deficits.
Sunny Today, Sunnier Tomorrow (the U.S. Case)
If pessimism about the future can help explain why
countries have current account surpluses, optimism
about the future may help explain why countries
have current account deficits. A deficit suggests a
country has more investment opportunities than its
domestic savers can fund. In this case, the country
can borrow from other nations to finance investment.
It also can borrow from other nations to finance
The factors that lead a country’s populace to become
more optimistic about the future are largely the reverse of the things that give rise to pessimism. If a
country has historically enjoyed a dynamic, growing
economy, its residents may reasonably expect this
to continue in the future. Despite concerns from
some observers that the United States has “run out of
ideas,” it is still home to many innovative firms such
as Apple, Amazon, and Google. A current account
deficit may in part reflect that American and foreign
investors alike still believe that more innovations are
on the horizon — self-driving cars, sustainable clean
energy, and nanotechnology, to name a few — and
that they are being driven by American firms.5
Relatively favorable demographics are another
reason to be optimistic about the future. While the
U.S. population is also graying, the trend is less pronounced than in some other developed nations. The
Census Bureau predicts that slightly less than one
in five Americans will be over the age of sixty-five in
2025. Another source of optimism is the presence
of unexploited resources. In the American case, advances in horizontal drilling with hydrofracturing
(or fracking) have unlocked new oil and natural gas
reserves and have transformed the United States
into an oil exporter. These new resources have translated into more jobs and higher wages for states
with oil and natural gas reserves.6
More generally, as described previously, a country’s
current account deficit may be driven by its capital
account surplus. For investors in many countries,

U.S. Treasury bonds remain a safe investment in
times of stress. If foreigners invest in more U.S. assets
than Americans invest in foreign assets, the United
States will run a capital account surplus. And by the
accounting logic of the balance of payments, this
imbalance means that the United States must run a
current account deficit.
However, it should be noted that current account
deficits not only originate in nations with high investment rates, but also can be driven by strong
consumption (and conversely low savings rates). If
an economy borrows from abroad to finance productive investment, then a current account deficit
has a built-in expiration date in that the returns from
higher production and productivity in the future
result in future current account surpluses. But foreign
borrowing to finance current consumption or a
budget deficit lacks this feature. This scenario could
become a cause for concern if creditors begin to
doubt the borrowing nation’s ability to repay debts.
What about Trade?
In the introduction of this Economic Brief, we noted
that trade accounts for the largest component of the
current account. But so far, we haven’t talked about
trade as a determinant of the current account. The
reason is that while a country’s exports and imports
determine the composition of its current account,
they do not determine the level. That, as argued
above, is largely determined by domestic macroeconomic factors.
By and large, these domestic macroeconomic factors
reflect a country’s aggregate views about the future
and are not inherently good or bad. However, there
are a few extreme cases that could be concerning.
A country that has a current account surplus due to
low investment could arguably be doing more to
invest in infrastructure and improve its future growth
outlook. And a country that runs a current account
deficit largely to finance consumption may face a
painful financial correction in the future. Ultimately,
however, these extreme cases do not change the fact
that current account surpluses and deficits have little
to do with trade deals and everything to do with
domestic economic decisions.

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Thomas A. Lubik is a senior advisor and Tim Sablik
is an economics writer in the Research Department
of the Federal Reserve Bank of Richmond.

I n a sense, a country that has a capital account deficit provides
funds, or capital, for the rest of the world. A country that has a
capital account surplus provides investment opportunities for
the rest of the world.


Incidentally, not all countries worry about current account
deficits. For example, like the United States, Australia has run
persistent current account deficits since the 1970s, but the
Australian public and policymakers have never been particularly concerned about this imbalance.


 hristian Dustmann, Bernd Fitzenberger, Uta Schönberg, and
Alexandra Spitz-Oener, “From Sick Man of Europe to Economic
Superstar: Germany’s Resurgent Economy,” Journal of Economic
Perspectives, Winter 2014, vol. 28, no. 1, pp. 167–188.


F or more on this discussion, see Aaron Steelman and John
A. Weinberg, “A ‘New Normal’? The Prospects for Long-Term
Growth in the United States,” Federal Reserve Bank of Richmond 2015 Annual Report.


Steelman and Weinberg (2015)


James Feyrer, Erin T. Mansur, and Bruce Sacerdote, “Geographic
Dispersion of Economic Shocks: Evidence from the Fracking
Revolution,” American Economic Review, April 2017, vol. 107,
no. 4, pp. 1313–1334 (article available with subscription).

This article may be photocopied or reprinted in its
entirety. Please credit the authors, source, and the
Federal Reserve Bank of Richmond and include the
italicized statement below.
Views expressed in this article are those of the authors
and not necessarily those of the Federal Reserve Bank
of Richmond or the Federal Reserve System.

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