Household Saving, Financial Constraints, and the Current Account in China∗

In this paper, we present a model economy that can account for the changes in the current account balance in China since the early 2000s. Our results suggest that the increase in the household saving rate and tighter financial constraints facing the firms played equally important roles in the increase in the current account surplus until 2008. We argue that inadequate insurance through government programs for the elderly and the decline in family insurance due to the one-child policy led to the increase in the household saving rate especially after 2000 as more and more families with only one child entered the economy. The increase in the saving rate coupled with the financial frictions preventing the increased household saving from being invested in domestic firms resulted in large current account surpluses until 2008. Our results also indicate that the decline in the current account surplus since 2008 was likely to be due to the relaxation of financial constraints facing domestic firms, which was a result of the largescale fiscal stimulus plan launched by the Chinese government after 2008. These findings imply that the planned increases in China’s public pension coverage are likely to reduce the future current account balances. On the other hand, if financial constraints are tightened back to the pre-stimulus levels; the current account surplus may rise again. ∗We thank Victor Rios-Rull, the seminar participants at University of California Santa Barbara, the 2017 Midwest Macro Meetings, the Facing Demographic Change in a Challenging Economic Environment Workshop in Montreal, and the 2017 Southern Economic Association Meeting for their comments. †Department of Finance and Business Economics, Marshall School of Business, University of Southern California, Los Angeles, CA 90089-0808. E-mail: [email protected] ‡Department of Economics, The University of Connecticut, Storrs, CT 06269-1063. Email: [email protected]