Because the current account deficit equals saving minus investment....Herein lies the silver lining. The housing turmoil has indeed cut a chunk out of investment – residential investment has fallen by $81bn in the three quarters during which the current account deficit declined, and even more compared with the peak of the housing boom earlier last year. Hence a good part of the current account reduction can be directly attributed to the decline in residential investment. Moreover, the decline in housing prices is starting to increase the personal saving rate, as home equity loans are drying up and people are recognising that their housing wealth is not as large as they had expected. When asset prices were rising, households could spend what they earned and still see an increase in their net worth. Sometimes spending even exceeded income. Now, consumption is falling relative to income, so there is more household saving.
Including both the direct investment effect and the personal saving effect, about three-quarters of the reduction in the current account deficit can be attributed to the housing market turmoil. So while the agreed economic policies have begun to improve the current account, and will continue to do so, they have had important assistance. The housing market correction has been an important factor in the current account correction; as a result we are seeing a dramatic beginning of a welcome rebalancing of the world’s investment and saving flows.
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