Feasible Limits for External Deficits and Debt

Abstract

Large current account deficits and foreign debt levels remain a source of concern for international financial markets and policymakers. Yet, exactly what an excessive external deficit or liability position for an advanced economy is at any time has never been adequately defined. This paper addresses the question by proposing new methods for assessing the proximity of current account deficits and the associated foreign debt to their upper bounds. It contends that productive investment fundamentally sets the feasible limit for current account deficits, whereas the capital to output ratio ultimately sets the foreign debt to GDP limit. Benchmark estimates for the United States, Australia, New Zealand and the United Kingdom, advanced economies that have borrowed heavily since 1990, reveal external deficits have usually been well within limits, although recent United States experience is an exception.