by Calculated Risk on 3/02/2005 07:05:00 PM

Here is a new paper that does an historical review of previous CAD adjustments , "Financial Market Developments and Economic Activity during Current Account Adjustments in Industrial Economies" by Croke, Kamin and Leduc.

The consequences of an adjustment in the current account deficit is being widely discussed. Some observers believe that an orderly adjustment is probable. Others, like Roubini and Setser, argue that a disorderly adjustment is very possible and "could result in a sharp economic slowdown in the US." This new paper looks at historical occurrences of Current Account Adjustments and Croke, Kamin and Leduc conclude:

"a significant subset of the adjustment episodes we studied were associated with substantial declines in GDP growth ... Thus, the fear that current account adjustment might be associated with recession is not entirely without basis."

BUT ...

"[O]ur second main finding is that the shortfall in growth experienced in the contraction episodes appears to reflect the playing out of standard cyclical developments rather than a response to current account adjustment."

My interpretation of their conclusion is that a CAD adjustment doesn't necessarily cause a recession, but a recession cures a CAD problem. Is that good news or bad?

NOTE: DeLong reviews another recent paper "The U.S. Current Account and the Dollar" by Oliver Blanchard, Francesco Giavazzi, Filipa Sa". I also recommend Macroblog and New Economist.

UPDATE: Both Macroblog and New Economist have posts reviewing this new paper.