Ben Bernanke will soon end his tenure as chairman of the US Federal Reserve system. A lot of attention is quite naturally focused on the way he ran monetary policy after he took over from Alan Greenspan in 2006. The one part of the Bernanke legacy that will attract the most attention is quantitative easing, the controversial programme under which the US central bank has been on a bond-buying spree funded with the creation of new money. The size of the Fed balance sheet has more than quadrupled since 2009 as a result of this unprecedented monetary expansion.

But it is an early Bernanke speech as a governor of the Fed that this column will focus on. Bernanke was already an accomplished macroeconomist when he joined the US central bank in 2002. His studies on the causes of the Great Depression showed that financial tremors can amplify even small shocks to the real economy, through a process that has come to be known as the financial accelerator. Bernanke also publicly said that Milton Friedman and Anna Schwartz were right when they argued in their monumental history of US monetary affairs that the collapse in economic activity during the Great Depression was because the Fed had tightened money supply when in fact it should have opened the spigots.

In 2005, Bernanke made a speech on a global savings glut that he said had pushed down long-term interest rates in the US. It is interesting to revisit that theme since the low cost of borrowing is now accepted to be one of the main reasons for the subsequent financial crisis that hit the developed countries in September 2008. Bernanke made this speech at a time when several other economists had also begun to say that global trade imbalances were one of the biggest threats to economic stability, in particular that growing current account deficits in the US combined with the growing current account surpluses in developing countries such as China.

There are two ways to look at the current account balance of any country. One way is to examine trade flows and the factors that affect them, particularly exchange rates. The more fundamental way is to look at the current account balance as the difference between domestic savings and investments. Bernanke stayed focused on the second approach.

He argued that the massive US current account deficit was partly linked to global factors, especially the rapid rise in the supply of global savings from the developing countries that had decided to build large foreign exchange reserves after the financial panics they faced in the 1990s. The two other factors were the rise in savings rate in some developed countries that were rapidly ageing as well as the surpluses with the oil exporters following the recovery in global oil prices in the early years of the current century.

“One of the factors driving recent developments in the US current account has been the very substantial shift in the current accounts of developing and emerging market nations, a shift that has transformed these countries from net borrowers on international capital markets to large net lenders. This shift by developing nations, together with the high saving propensities of Germany, Japan, and some other major industrial nations, has resulted in a global saving glut. This increased supply of saving boosted US equity values during the period of the stock market boom and helped to increase US home values during the more recent period, as a consequence lowering US national saving and contributing to the nation’s rising current account deficit," said Bernanke.

Many critics pointed out at the time that Bernanke was implicitly shifting the blame for the large US current account deficit to the developing countries rather than its own profligate ways. But let us for now stay with the Bernanke hypothesis and look at what has happened to global imbalances in recent quarters. The most useful way is to see what has happened to the US current account deficit on the one hand and the Chinese current account surplus on the other. The chart shows that global imbalances have considerably eased.

What does this mean? One, US savings have improved as households have deleveraged. Two, Chinese surplus savings in excess of its investment rate have come down. If the global savings glut that Bernanke spoke about in 2005 had pushed down long-term US interest rates, then it is perhaps likely that the recent correction in global imbalances will have the opposite effect—long-term US interest rates will rise. This, in turn, could affect a range of global economic variables, including capital flows.

The prospect of a gradual reduction in quantitative easing in the coming months has already led to rising bond yields in the US. But an equally important factor to watch out for is the simultaneous reduction in the US current account deficit and the Chinese current account surplus.

Niranjan Rajadhyaksha is executive editor of Mint. Comments are welcome at cafeeconomics@livemint.com To read Niranjan Rajadhyaksha’s previous columns, go to www.livemint.com/cafeeconomics-

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