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Financial market developments and economic activity during current account adjustments in industrial economies

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Author Info
Hilary Croke
Steven B. Kamin
Sylvain Leduc

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Abstract

Much has been written about prospects for U.S. current account adjustment, including the possibility of what is sometimes referred to as a "disorderly correction": a sharp fall in the exchange rate that boosts interest rates, depresses stock prices, and weakens economic activity. This paper assesses some of the empirical evidence bearing on the likelihood of the disorderly correction scenario, drawing on the experience of previous current account adjustments in industrial economies. We examined the paths of key economic performance indicators before, during, and after the onset of adjustment, building on the analysis of Freund (2000). We found little evidence among past adjustment episodes of the features highlighted by the disorderly correction hypothesis. Although some episodes in our sample experienced significant shortfalls in GDP growth after the onset of adjustment, these shortfalls were not associated with significant and sustained depreciations of real exchange rates, increases in real interest rates, or declines in real stock prices. By contrast, it was among the episodes where GDP growth picked up during adjustment that the most substantial depreciations of real exchange rates occurred. These findings do not preclude the possibility that future current account adjustments could be disruptive, but they weaken the historical basis for predicting such an outcome.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 827.

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Date of creation: 2005
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Handle: RePEc:fip:fedgif:827

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Keywords: Balance of payments ; Balance of trade;

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  1. Milesi-Ferretti, Gian Maria & Razin, Assaf, 1998. "Current Account Reversals and Currency Crises: Empirical Regularities," CEPR Discussion Papers 1921, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  2. Freund, Caroline, 2005. "Current account adjustment in industrial countries," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1278-1298, December. [Downloadable!] (restricted)
  3. Sebastian Edwards, 2004. "Thirty Years of Current Account Imbalances, Current Account Reversals and Sudden Stops," NBER Working Papers 10276, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. P. Krugman & L. Taylor, 1976. "Contractionary Effects of Devaluations," Working papers 191, Massachusetts Institute of Technology (MIT), Department of Economics.
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  5. Maurice Obstfeld & Kenneth Rogoff, 2004. "The Unsustainable US Current Account Position Revisited," NBER Working Papers 10869, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Carlos F. Diaz Alejandro, 1963. "A Note on the Impact of Devaluation and the Redistributive Effect," Journal of Political Economy, University of Chicago Press, vol. 71, pages 577. [Downloadable!] (restricted)
  7. Shaghil Ahmed & Christopher J. Gust & Steven B. Kamin & Jonathan Huntley, 2002. "Are depreciations as contractionary as devaluations? A comparison of selected emerging and industrial economies," International Finance Discussion Papers 737, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  8. Catherine L. Mann, 2002. "Perspectives on the U.S. Current Account Deficit and Sustainability," Journal of Economic Perspectives, American Economic Association, vol. 16(3), pages 131-152, Summer. [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. 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:
  2. Sebastian Edwards, 2005. "Is the U.S. Current Account Deficit Sustainable? And If Not, How Costly is Adjustment Likely To Be?," NBER Working Papers 11541, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Christopher Erceg & Luca Guerrieri & Christopher Gust, 2006. "Trade adjustment and the composition of trade," International Finance Discussion Papers 859, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  4. Sebastian Edwards, 2006. "The U.S. Current Account Deficit: Gradual Correction or Abrupt Adjustment?," NBER Working Papers 12154, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Maurice Obstfeld & Kenneth Rogoff, 2005. "The Unsustainable US Current Account Position Revisited," Center for International and Development Economics Research, Working Paper Series 1063, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley. [Downloadable!]
    Other versions:
  6. Sebastian Edwards, 2005. "The End of Large Current Account Deficits, 1970-2002: Are There Lessons for the United States?," NBER Working Papers 11669, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  7. Bernardina Algieri & Thierry Bracke, 2007. "Patterns of Current Account Adjustment – Insights from Past Experience," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  8. Miranda Xafa, 2007. "Global Imbalances and Financial Stability," IMF Working Papers 07/111, International Monetary Fund. [Downloadable!]
  9. Caroline Freund & Frank Warnock, 2005. "Current Account Deficits in Industrial Countries: The Bigger They are, the Harder They Fall?," NBER Working Papers 11823, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Hostland, Doug & Karam, Philippe, 2006. "Assessing debt sustainability in emerging market economies using stochastic simulation methods," Policy Research Working Paper Series 3821, The World Bank. [Downloadable!]
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  11. Roberto A. De Santis & Melanie Lührmann, 2006. "On the determinants of external imbalances and net international portfolio flows - a global perspective," Working Paper Series 651, European Central Bank. [Downloadable!]
  12. Morten Spange & Pawel Zabczyk, . "Sterling implications of a US current account reversal," Bank of England working papers 296, Bank of England. [Downloadable!]
  13. Bernardina Algieri & Thierry Bracke, 2007. "Patterns of current account adjustment - insights from past experience," Working Paper Series 762, European Central Bank. [Downloadable!]
  14. Edwin M. Truman, 2005. "Postponing Global Adjustment: An Analysis of the Pending Adjustment of Global Imbalances," Peterson Institute Working Paper Series WP05-6, Peterson Institute for International Economics. [Downloadable!]
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