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This paper builds a two-country model with differential productivity and financial frictions to quantitatively account for the recent increase in the U.S. current account deficit. An influential literature says that as U.S. productivity surged, capital was attracted to the United States to take advantage of the high returns to investment. We show, however, that when we include emerging Asia, the gap in productivity growth between the United States and the rest of the world cannot explain the U.S. current account deficits, especially since 2000. This is because on a gross domestic product-weighted basis, the rest of the world actually had higher productivity growth during this period; and standard macroeconomic models would predict an outflow of funds from the United States to the rest of the world, and a consequent narrowing of the U.S. current account deficit. This paper shows that greater financial integration abroad can explain this anomaly. However, we still cannot explain why U.S. per capita output growth has been so low, despite the large inflow of capital.IMF Staff Papers (2009) 56, 655–682. doi:10.1057/imfsp.2009.4; published online 31 March 2009 [ABSTRACT FROM AUTHOR]

There has been much concern recently that large U.S. deficits have, or will soon, produce high interest rates, thus hindering capital formation and economic growth in the U.S. and the rest of the world. In this paper, the author surveys U.S. history to determine whether this concern has merit. There are three periods during which the federal deficit has exceeded 10 percent of national income. In none of these periods did interest rates rise appreciably. Regression analysis applied to data from these three periods has not uncovered a positive association between deficits and interest rates. Economists like to think of economics as a science. In a science, repeated contradictions of a paradigm lead to its abandonment if there is any sensible alternative. One paradigm in economics implies that large deficits produce high interest rates. This paradigm is not supported by the facts. In over a century of U.S. history, large deficits have never been associated with high interest rates. Even the postwar periods separately offer no support for a positive association between deficits and interest rates. Indeed, the evidence more strongly supports a negative association than a positive one. Therefore, it seems that economists should be looking for an alternative paradigm to replace their current one.