The size of external imbalances, the capital flows associated with them, and the accompanying constellation of interest rates and exchanges rates reflect a range of factors, from differences in actual and potential growth rates, and the degree of competition in financial and product markets and the presence or absence of capital controls, to differences in monetary and exchange rate arrangements, the degree of financial market development, and the net borrowing requirements of governments, and to a whole range of different factors that affect savings preferences and the perceived return on private investment. The relative importance of these factors is hard to assess, as is their likely persistence. And this complicates the task of understanding the implications for policy. The challenge of explaining these anomalies is illustrated by considering some of the explanations now prevailing. The decline of thrift in the United States is one common explanation. The sustained decline in net national savings in the United States is the necessary counterpart to the rise in the current account deficit. But this observation does not explain why that growth has not been accompanied by an increase in longer-term interest rates. The robust productivity outlook for the United States relative to the rest of the world is consistent with an increase in the U.S. current account deficit, such as we experienced in the late 1990s. If this gap in potential growth were sustained, the United States would be able to sustain a larger external imbalance than we might have thought historically would be the case.
For the same reason, this phenomenon can act to mask or offset the effects of high levels of present and expected future government borrowing on interest rates, perhaps contributing to a false sense of reassurance that we can continue to run large structural deficits without risk of crowding out private investment and damaging future growth. BIS Review 18/2006  3  What might this mean for the conduct of monetary policy? To the extent that these forces act to put downward pressure on interest rates and upward pressure on other asset prices, they would contribute to more expansionary financial conditions than would otherwise be the case. And, if all else were equal, which of course is unlikely ever to be the case, monetary policy in the affected countries would have to adjust in response; policy would have to act to offset these effects in order to achieve the same impact on the future path of demand and inflation. To do otherwise would run the risk that monetary policy would be too accommodative, pulling resources from the future in a way that would alter the trajectory for the growth of the capital stock, perhaps amplifying the imbalances, and compromising the price stability. Finally, these aspects of global monetary arrangements and financial conditions have important implications for how we communicate about monetary policy. They strengthen the case for why central banks should be clear about their objectives and credible in their commitment to price stability.