Fundamentals At Odds? T+L4130he U.S. Current Account Deficit and the Dollar

Abstract

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. In mid-2008, the real effective exchange rate of the dollar was close to its minimum level for the past 4 decades. At the same time, however, the U.S. trade and current account deficits remain large and, absent a significant correction in coming years, would contribute to a further accumulation of U.S. external liabilities. The paper discusses the tension between these two aspects of the dollar assessment, and what factors can help reconcile them. It focuses in particular on the terms of trade, adjustment lags, and measurement issues related to both the real effective exchange rate and the current account balance.

Effective Exchange Rates, Current Accounts and Global Imbalances

“…To explain a potential causality running from effective exchange rates to current accounts, consider the following simplified model equation introduced by Milesi‐Ferretti (). The current account is expressed as the sum of trade balance tb t , net exports of services nse t , net receipts from interest, dividends and profits nir t and net unilateral receipts nur t …”

Effective Exchange Rates, Current Accounts and Global Imbalances

“…5 If for example, U.S. foreign liabilities are mainly denominated in dollars, while most U.S. foreign assets are denominated in a foreign currency, a depreciation of the dollar will improve the net foreign asset position (Milesi-Ferretti, 2008). Hence, trade and evaluation effects stemming from exchange rates should be qualitatively equivalent.…”

“…To explain a potential causality running from effective exchange rates 4 to current accounts, consider the following simplified model equation introduced by Milesi-Ferretti (2008). The current account is expressed as the sum of trade balance (tb t ), net exports of services (nse t ), net receipts from interest, dividends and profits (nir t ), and net unilateral receipts (nur t )…”

“…If we disregard net exports of services and net unilateral receipts, the current account can be written as the sum of trade balance and net investment income which is driven by the interest rate differential between interest on domestic assets (a) and loans (l) (Milesi-Ferretti, 2008).…”

International Financial Integration and the External Positions of Euro Area Countries

“…The creation of the euro represented a fundamental financial shock (see also Lane, 2010, andLane andMilesi-Ferretti, 2008). By eliminating currency risk among the member countries, a critical barrier to international financial integration was dismantled, especially in relation to debt instruments.…”