The U.S. deficit in the current account, now running at an annual rate of over US$700 billion, has reached levels (as a percentage of GDP) not seen since the first decades of the 19th century. The deficit is soaking up roughly three-quarters of the world's available external surpluses. If the deficit continues at this pace, the U.S. could ultimately converge to an external debt/GDP ratio around one. Several analyses suggest that a rapid adjustment of the deficit toward balance would require a very sharp real depreciation of the U.S. dollar. This paper reviews the limitations of some optimistic arguments that predict instead a "soft landing" for the dollar. I focus in particular on the view that greater financial globalization allows the United States easily to run much bigger deficits for much longer periods. Some simple calculations based on real interest rate differentials suggest that markets could be underestimating the extent of necessary dollar depreciation.
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Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.
Volume (Year): 23 (2005) Issue (Month): S1 (October) Pages: 25-35 Download reference. The following formats are available: HTML,
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Find related papers by JEL classification: F31 - International Economics - - International Finance - - - Foreign Exchange F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates