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Could capital gains smooth a current account rebalancing?

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Author Info
Michele Cavallo
Cédric Tille

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Abstract

A narrowing of the U.S. current account deficit through exchange rate movements is likely to entail a substantial depreciation of the dollar, as stressed in the widely cited contribution by Obstfeld and Rogoff (2005). We assess how the adjustment is affected by the high degree of international financial integration in the world economy. A growing body of research stresses the increasing leverage in international financial positions, with industrialized economies holding substantial and growing financial claims on each other. Exchange rate movements then leads to valuations effects as the currency compositions of a country's assets and liabilities are not matched. In particular, a dollar depreciation generates valuation gains for the U.S. by boosting the dollar value of the large amount of its foreign-currency denominated assets. We consider an adjustment scenario in which the U.S. net external debt is held constant. The key finding is that while the current account moves into balance, the pace of adjustment is smooth. Intuitively, the valuation gains stemming from the depreciation of the dollar allow the U.S. to finance ongoing, albeit shrinking, current account deficits. We find that the smooth pattern of adjustment is robust to alternative scenarios, although the ultimate movements in exchange rates are affected.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2006-03.

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Date of creation: 2006
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Handle: RePEc:fip:fedfwp:2006-03

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Keywords: Balance of trade ; Foreign exchange rates;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Maurice Obstfeld & Kenneth Rogoff, 2005. "The unsustainable U.S. current account position revisited," Proceedings, Federal Reserve Bank of San Francisco, issue Feb. [Downloadable!]
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  2. Matthew Higgins & Thomas Klitgaard & Cedric Tille, 2005. "The income implications of rising U.S. international liabilities," Current Issues in Economics and Finance, Federal Reserve Bank of New York, issue Dec. [Downloadable!]
  3. Caballero, Ricardo & Farhi, Emmanuel & Gourinchas, Pierre-Olivier, 2006. "An Equilibrium Model of 'Global Imbalances' and Low Interest Rates," CEPR Discussion Papers 5573, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  4. David Backus & Espen Henricksen & Frederic Lambert & Chris Telmer, 2005. "Current Account Fact and Fiction," 2005 Meeting Papers 115, Society for Economic Dynamics.
  5. Maurice Obstfeld, 2004. "External Adjustment," NBER Working Papers 10843, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Gourinchas, Pierre-Olivier & Rey, Hélène, 2005. "International Financial Adjustment," CEPR Discussion Papers 4923, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  7. Michael P. Dooley & David Folkerts-Landau & Peter M. Garber, 2005. "Savings Gluts and Interest Rates: The Missing Link to Europe," NBER Working Papers 11520, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Cedric Tille, 2005. "Financial integration and the wealth effect of exchange rate fluctuations," Staff Reports 226, Federal Reserve Bank of New York. [Downloadable!]
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  9. Philip R. Lane & G.M. Milesi-Ferretti, 2003. "International Financial Integration," Trinity Economics Papers 20031, Trinity College Dublin, Department of Economics. [Downloadable!]
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  10. Matthew Higgins & Thomas Klitgaard, 2004. "Reserve accumulation: implications for global capital flows and financial markets," Current Issues in Economics and Finance, Federal Reserve Bank of New York, issue Sep. [Downloadable!]
  11. Maurice Obstfeld & Kenneth S. Rogoff, 2005. "Global Current Account Imbalances and Exchange Rate Adjustments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(2005-1), pages 67-146. [Downloadable!]
  12. Cedric Tille, 2003. "The impact of exchange rate movements on U.S. foreign debt," Current Issues in Economics and Finance, Federal Reserve Bank of New York, issue Jan. [Downloadable!]
  13. Richard H. Clarida, 2006. "G7 Current Account Imbalances: Sustainability and Adjustment," NBER Working Papers 12194, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  14. Linda S. Goldberg & Cedric Tille, 2005. "Vehicle Currency Use in International Trade," NBER Working Papers 11127, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Michael Dooley & David Folkerts-Landau & Peter Garber, 2005. "Direct investment, rising real wages and the absorption of excess labor in the periphery," Proceedings, Federal Reserve Bank of San Francisco, issue Feb. [Downloadable!]
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  16. Gian Maria Milesi-Ferretti & Philip R. Lane, 2005. "A Global Perspective on External Positions," IMF Working Papers 05/161, International Monetary Fund. [Downloadable!]
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  17. Gian Maria Milesi-Ferretti & Philip R. Lane, 2005. "Financial Globalization and Exchange Rates," IMF Working Papers 05/3, International Monetary Fund. [Downloadable!]
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  18. Olivier Blanchard & Francesco Giavazzi & Filipa Sa, 2005. "The U.S. Current Account and the Dollar," NBER Working Papers 11137, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  19. Hamid Faruqee & Douglas Laxton & Dirk Muir & Paolo Pesenti, 2005. "Smooth Landing or Crash? Model-Based Scenarios of Global Current Account Rebalancing," NBER Working Papers 11583, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Gian Maria Milesi-Ferretti & Philip R. Lane, 2007. "Europe and Global Imbalances," IMF Working Papers 07/144, International Monetary Fund. [Downloadable!]
    Other versions:
  2. Enrique G. Mendoza & Vincenzo Quadrini & Jose-Victor Rios-Rull, 2007. "Financial Integration, Financial Deepness and Global Imbalances," NBER Working Papers 12909, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Stephanie E. Curcuru & Tomas Dvorak & Francis E. Warnock, 2007. "The Stability of Large External Imbalances: The Role of Returns Differentials," NBER Working Papers 13074, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Stephanie E. Curcuru & Charles P. Thomas & Francis E. Warnock, 2008. "Current Account Sustainability and Relative Reliability," NBER Working Papers 14295, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Christian M. Oberpriller, 2007. "Exchange Rates and Global Imbalances: The Importance of Asset Valuation Effects and Interest Rate Changes," Kiel Advanced Studies Working Papers 443, Kiel Institute for the World Economy. [Downloadable!]
  6. Joerg Bibow, 2006. "Global Imbalances, Bretton Woods II, and Euroland's Role in All This," Economics Working Paper Archive wp_486, Levy Economics Institute, The. [Downloadable!]
  7. Ziesemer, Thomas, 2007. "Estimations of US debt dynamics: Growth cum debt and the savings glut in Kouri’s model," UNU-MERIT Working Paper Series 003, United Nations University, Maastricht Economic and social Research and training centre on Innovation and Technology. [Downloadable!]
  8. Marcel Fratzscher & Luciana Juvenal & Lucio Sarno, 2007. "Asset prices, exchange rates and the current account," Working Paper Series 790, European Central Bank. [Downloadable!]
    Other versions:
  9. Stephanie E. Curcuru & Charles P. Thomas & Francis E. Warnock, 2008. "Current account sustainability and relative reliability," International Finance Discussion Papers 947, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  10. Marques, Luis B, 2007. "Welfare Implications of Exchange Rate Changes," MPRA Paper 5721, University Library of Munich, Germany. [Downloadable!]
  11. Pierpaolo Benigno, 2006. "Are Valuation Effects Desirable from a Global Perspective?," NBER Working Papers 12219, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Michele Cavallo & Cédric Tille, 2006. "Current account adjustment with high financial integration: a scenario analysis," Economic Review, Federal Reserve Bank of San Francisco, pages 31-45. [Downloadable!]
  13. Michael B. Devereux & Hans Genberg, 2006. "Currency Appreciation and Current Account Adjustment," Working Papers 172006, Hong Kong Institute for Monetary Research. [Downloadable!]
    Other versions:
  14. Stephanie E. Curcuru & Tomas Dvorak & Francis Warnock, 2007. "Cross-border returns differentials," Globalization and Monetary Policy Institute Working Paper 04, Federal Reserve Bank of Dallas. [Downloadable!]
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