External imbalances and the US current account - how supply-side changes affect an exchange rate adjustment
AbstractThe influential work of Obstfeld and Rogoff argues that a closing-up of the US current account deficit involves a large exchange rate adjustment. However, the Obstfeld-Rogoff model works exclusively via demand-side channels and abstracts from possible supply-side changes. We extend the framework to allow for endogenous supply-side changes and show that this fundamentally alters the mechanism of the adjustment process. Allowing for such an extension attenuates quite significantly the implied exchange rate adjustment. The paper also provides some empirical evidence of variations in the supply-side structure and correlations with the exchange rate and the current account. The policy implications are that measures to foster a supply-side reaction would facilitate the external adjustment by alleviating an exclusive reliance on demand and exchange rate changes, with the latter being potentially destabilising for the global financial system. JEL Classification: E2, F32, F41.
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Bibliographic InfoPaper provided by European Central Bank in its series Working Paper Series with number 761.
Length: 41 pages
Date of creation: Jun 2007
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Find related papers by JEL classification:
- E2 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment
- F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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- NEP-ALL-2007-07-07 (All new papers)
- NEP-CBA-2007-07-07 (Central Banking)
- NEP-IFN-2007-07-07 (International Finance)
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