CURRENT ACCOUNT DEFICITS: THE AUSTRALIAN DEBATE

Abstract

Large and persistent current account deficits are frequently raised as a cause for concern for a number of reasons. Perhaps the key concern is that countries in this situation could be on a path to insolvency, building up excessive net foreign debt, raising the prospects of default or a sharp reversal in capital flows, which might force an abrupt and costly adjustment.1 Large deficits and rising indebtedness could also leave countries more vulnerable to adverse external shocks, including a change in sentiment on the part of foreign creditors. Some argue that policymakers should take steps to ensure that countries move toward a sustainable position in which the current account deficit is not so large that it will lead to an excessive build-up in foreign indebtedness. 1. Milesi-Ferretti and Razin (1996) provide a thorough discussion of solvency (when the intertemporal budget constraint is satisfied) and sustainability (whereby the current account deficit is small enough that net foreign liabilities do not rise as a share of GDP). Optimality, by definition, will satisfy solvency, but it will not necessarily satisfy sustainability.

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