Recently, Germany’s current account surpluses have been a cause of concern both in the public debate as well as in policy circles. Although accumulating net foreign assets appears reasonable against the background of population ageing, one of the criticisms that has been voiced repeatedly in this regard is that Germany’s savings are being squandered abroad. In order to disentangle the dynamics of the German investment income balance, we apply a novel decomposition framework to a rich German dataset spanning 11 different asset classes between 1999 and 2014. First, we show that Germany gained a yield privilege in this time period and that it would not have been more profitable to invest German savings in domestic assets. Second, the accumulation of net foreign assets accounted for 60% of the rise in the investment income balance. Third, the global decline in interest rates in the aftermath of the global financial crisis led to an appreciable dent in net investment income receipts, which leaves scope for a risk sharing interpretation.
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Germany’s current account surplus has been larger than 4% of GDP since 2004 and Germany is expected to run the world’s largest current account surplus in 2016 measured at market exchange rates.
In 2011, 47 out of 188 countries had a positive net foreign asset position, while for 24 the net foreign asset position was larger than 40% of GDP according to the updated and extended version of the dataset constructed by Lane and Milesi-Ferretti (2007).
We provide a survey of the literature in Sect. 2.
This sometimes also refers to the presumed benefit of the United States deriving from the US dollar being an international reserve currency.
For example, with French gross claims and liabilities standing at roughly 210% of GDP each in 2005 (Lane and Milesi-Ferretti 2007), a 0.5% point improvement in the yield spread would have resulted in a more than 1% point increase in its net investment income relative to GDP.
Note that changes in assets and liabilities can, in principle, derive from current account surpluses or deficits, and/or valuation effects and other changes in volume (see Section A.5.1 in the Electronic Supplementary Material for a detailed discussion of this point).
See Section A.1 in the Electronic Supplementary Material for a derivation.
Alternative definitions—such as using the yield on assets as a reference point (Knetsch and Nagengast 2016)—are conceivable, but do not change the results appreciably.
For example, ceteris paribus, the aggregate yield spread increases if the yields on assets and liabilities of a given investment category both increase by the same amount if this particular investment class has a higher weight in a country’s foreign assets than its foreign liabilities [see Knetsch and Nagengast (2016) for an example].
See Section A.2 in the Electronic Supplementary Material for a derivation. Note that similar to the division of the yield effect we take the arithmetic mean of the weights on the asset and liability side for the pure yield spread effect and the arithmetic mean of the yields on assets and liabilities for the portfolio effect.
Section A.3 in the Electronic Supplementary Material details the technicalities of implementing the decomposition in discrete time. In Knetsch and Nagengast (2016) we provide a range of examples of the individual effects of the decomposition in order to help build intuition.
We would like to thank the editor, Cedric Tille, for suggesting this additional decomposition. Additional sub-divisions of the two main effects are conceivable, but beyond the scope of this paper.
Financial derivatives are excluded from our analysis since no primary income accrues on them (International Monetary Fund 2009). Cross-border holdings of euro currency, which are recorded in the international investment position according to the 6th edition of the Balance of Payments Manual, were excluded for the same reason (Deutsche Bundesbank 2015). Interest-bearing reserve assets are accounted for in the sub-category Bundesbank.
The payments on Bundesbank liabilities for the years 1999 and 2000 in the official statistics were adjusted downwards in order to avoid implausibly high yield estimates.
The TARGET2 balance differs from the other investment categories in that it is a net concept, i.e. either the asset or the liability side is positive with the counterpart being equal to zero for every point in time. The same holds for the income and payments that result from the TARGET2 balance. Initially, the TARGET2 balance generates interest income in accordance with the ECB’s main refinancing operations, which is recorded as investment income in the participating countries’ balance of payment statistics. However, all revenue and expenditure of individual central banks in the Eurosystem related to monetary policy operations is cleared at the end of each year and distributed according to the official capital key of the ECB. As the TARGET2 system as a whole does not generate any revenue, national central banks effectively make (receive) a payment in the amount of the initial interest receipt (payment), which is recorded as secondary income in the balance of payments. Since the initial investment income is offset by a flow of the same absolute magnitude but opposite sign in the secondary income account, TARGET2 balances do not generate any income from the perspective of the current account as a whole (Ulbrich and Lipponer 2012). See the Electronic Supplementary Material for an additional analysis considering the robustness of our results regarding the allocation of TARGET2 income towards the investment income balance.
Note that the yield on TARGET2 was set to zero as discussed in Sect. 4.1.
In the following, we focus on the results using the Shapley-Siegel decomposition (Section A.3 in the Electronic Supplementary Material) and present the results using the Logarithmic Mean Divisia Index decomposition as a robustness check in the Electronic Supplementary Material.
At this stage two qualifications are in order. First, all of the following results are based on implied returns, which may differ from the “true” returns due to a range of statistical issues (Curcuru et al. 2008). Second, in line with the previous literature we study “accounting” returns as measured by official statistics. Naturally, this excludes potential gains in terms of higher potential output and per capita income deriving from domestic investment such as infrastructure investment and research and development.
Overall, both domestic and foreign investors shifted their portfolios towards higher-yielding investment classes in the time period under consideration, which resulted in a positive asset composition change effect of EUR 9.3 bn and a negative liability composition change effect of EUR 17.2 bn. Netting both composition effects suggests that on balance Germany lost out from compositional changes in its international investment position. On the asset side institutional mechanisms within the euro area and the process of combating the crisis implied that the private sector’s share in external assets shifted in favour of public sector entities—particularly the Bundesbank’s TARGET2 claims. However, changes in the TARGET2 position are not an active investment decision of German residents, but are linked to cross-border payment transaction in the euro area (Ulbrich and Lipponer 2012). Therefore, these results should not be interpreted as suggesting that foreign investors were more savvy in reshuffling their investment portfolios than Germans (see also Section A.5 in the Electronic Supplementary Material).
Note that quantitatively these are also the most important investment categories in Germany’s foreign assets and liabilities (Fig. 6).
As discussed in Sect. 4.1 these are offset by a flow of the same absolute magnitude but opposite sign in the secondary income account.
We would like to thank an anonymous referee for raising this point.
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The views expressed in this paper are those of the authors and do not necessarily reflect those of the Deutsche Bundesbank. This is a substantially revised version of an earlier paper entitled “On the Dynamics of the Investment Income Balance”. We would like to thank the editor, Cedric Tille, and two anonymous referees for very insightful comments that greatly improved the paper. We would also like to thank Annette Döing, Carsten Hartkopf, Stefan Hopp, Christiane Jäcker and Ursula Schipper for invaluable help with the data. Suggestions made by Rainer Frey, Ulrich Grosch, Hermann-Josef Hansen, Axel Jochem, Stephan Kohns, Alexander Lipponer and Jens Ulbrich relating to on an earlier version of this manuscript are gratefully acknowledged. All remaining errors are our own.
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Knetsch, T.A., Nagengast, A.J. Penny wise and pound foolish? On the income from Germany’s foreign investments. Rev World Econ 153, 753–778 (2017). https://doi.org/10.1007/s10290-017-0283-3
- Investment income balance
- Return differential
- Exorbitant privilege
- International risk sharing