Experience with current account adjustments by industrialized economies--for example, by the United States in the 1980s--suggests that the transition to a more sustainable configuration is not likely to be disruptive. But we cannot be sure, particularly because the U.S. experience is unique given the dollar’s role as a reserve currency and Americans’ relatively favorable returns on assets held abroad. The world economy is in uncharted territory with regard to the size of the imbalances.

Continued strong demand for dollar assets will be critical to keeping that unwinding [of current account imbalances] smooth and not disruptive. The Federal Reserve can contribute by being sure the public remains confident that the purchasing power of their dollar assets will not erode unexpectedly. As long as inflation expectations remain contained, relatively faster growth of the prices of imported goods for a time would be associated with only a temporary bulge in inflation and would result in a needed change in relative prices.

Longstanding concerns about global imbalances remain with us as well.  Along with greater national saving in the United States, increased domestic demand in countries with current account surpluses and a greater flexibility of exchange rates more broadly would help to reduce those imbalances over time.  Should US economic growth moderate as expected, sustaining the global expansion will require a greater reliance by our trading partners on their own domestic spending as a source of growth.

It is also hard to assess the degree to which the current constellation of global monetary conditions has influenced the behavior of long-term interest rates. This makes it harder to assess the appropriateness of the current stance of monetary policy. And it may also mask some of the pressures on risk premiums we might expect to see given the deterioration of the U.S. long-term fiscal situation and the magnitude of the U.S. current account imbalance.

An economy the size of the U.S. cannot run large current account deficits indefinitely. For it to do so, the rest of the world would have to run persistently high net saving rates. Eventually, these countries will want to consume or invest more in their own countries. With fewer funds available, the U.S. current account deficit would fall.

No one can say when this adjustment away from such high current account deficits will begin. But I expect that when it does, the adjustment will be gradual, without a major disruption to U.S. economic performance. One reason is that many of the forces driving investment and saving in the U.S. and the rest of the world are long-lived developments driven by fundamental economic factors.

Though seemingly unrelated, financial education and the current account deficit are two long-term issues that we must focus on if we want to ensure that the economy remains strong in the future. Both topics at their core deal with understanding how current spending—by the individual or by the nation—must be balanced against future income prospects and future needs.

As foreign holdings of U.S. assets increase, at some point foreigners may become less willing to add these assets to their portfolios. While it is likely that current account imbalances will be resolved gradually over time, there is a small risk of a sudden shift in sentiment that could lead to disruptive changes in the value of the dollar and in other asset prices.

To reduce its dependence on foreign capital, the United States should take action to increase its national saving rate. The most direct way to accomplish this objective would be by putting federal government finances on a more sustainable path.

The US really can't solve the current account deficit problem by itself.  It is a global issue.  We need the cooperation of our trading partners.  And altogether, by taking actions which are in our own individual interests, we can also help create a better balance in terms of trade flows as well.

Over the longer-term, if we want to keep improving our standard of living, we must make sure that productivity growth remains robust. Faster productivity growth generates faster GDP growth. This boosts our well-being. It also helps make the adjustments to the current account and fiscal deficits a much smoother process than if we were facing them from a base of lower GDP growth.

Research by economists at the Federal Reserve Board of Governors suggests that an exogenous $1 reduction in the U.S. fiscal deficit would cause the current account deficit to decline by less than 20 cents. So, this evidence suggests the growing fiscal imbalances do not explain the bulk of the change in U.S. net saving or the current account.

The low real interest rates throughout the world over the last several years suggest that the most important factors underlying the recent increase in the U.S. current account deficits have been shifts in the desired net savings by the rest of the world. Reductions in desired U.S. net saving may have played a role as well. But if a fall in U.S. desired saving was dominant, interest rates would have risen, not fallen.

No one can say when this adjustment away from such high current account deficits will begin. But I expect that when it does, the adjustment will be gradual, without a major disruption to U.S. economic performance. One reason is that many of the forces driving investment and saving in the U.S. and the rest of the world are long-lived developments driven by fundamental economic factors.

The most likely scenario is for a slow decline in the net saving rate by the rest of the world that would induce a gradual contraction in the U.S. current account deficit. This probably would not have a major impact on U.S. price pressures or growth, so there is little reason to think that monetary policy would need to react significantly.