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Documents in EconStor may• from the SSRN website:www. SSRN.com • from the RePEc website:www.RePEc.org• from the CESifo website:T www. CESifo-group.deT CESifo Working Paper No. 1805
UNITED STATES CURRENT ACCOUNT DEFICITS: A STOCHASTIC OPTIMAL CONTROL ANALYSIS AbstractThe "Pessimists" and the "Optimists" disagree whether the US external deficits and the associated buildup of US net foreign liabilities are problems that require urgent attention. A warning signal should be that the debt ratio deviates significantly from the optimal ratio. The optimal debt ratio or debt burden should take into account the vulnerability of consumption to shocks from the productivity of capital, the interest rate and exchange rate. The optimal debt ratio is derived from inter-temporal optimization using Dynamic Programming, because the shocks are unpredictable, and it is essential to have a feedback control mechanism. The optimal ratio depends upon the risk adjusted net return and risk aversion both at home and abroad. On the basis of alternative estimates, we conclude that the Pessimists' fears are justified on the basis of trends. The trend of the actual debt ratio is higher than that of the optimal ratio. The Optimists are correct that the current debt ratio is not a menace, because the current level of the debt ratio is not above the corresponding level of the optimum ratio.JEL Code: C61, F32, F34, F37.Keywords: U.S. current account deficits, external debt, stochastic optimal control, dynamic programming, inter-temporal optimization.
Jerome L. Stein Division of Applied MathematicsBox F Brown University Providence RI 02912 USA Jerome_Stein@Brown.edu I am deeply grateful to Peter Clark for his insightful criticisms of a previous draft and suggestions for revision.
Pessimists and OptimistsFor nearly a quarter of a century, the US has persistently run significant current account deficits. The cumulative consequence of these deficits is that the US has been transformed from the world's largest net creditor to its largest debtor. The current account can be viewed in several ways. It is net foreign investment, equal to national saving less investment. A positive (negative) current account is equal to a capital outflow (inflow).National saving is the sum of private saving of firms and households plus government saving (the budget surplus). The current account is defined as the sum of the trade balance of goods...