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Could capital gains smooth a current account rebalancing?

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Author Info
Michele Cavallo
Cedric Tille () (Federal Reserve Bank of New York)

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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 research by Obstfeld and Rogoff. We assess how the adjustment is affected by the high degree of financial integration in the world economy. A growing body of research emphasizes the increasing leverage in international financial positions, with industrialized economies holding substantial and growing financial claims on each other. Exchange rate movements then lead to valuation effects as the currency composition of a country's assets and liabilities are not matched. In particular, a dollar depreciation generates valuation gains for the United States by boosting the dollar value of much 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 as the current account moves into balance, the pace of adjustment is smooth. Intuitively, the valuation gains from the depreciation of the dollar allow the United States 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 will vary under different conditions

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 252.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:252

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Related research
Keywords: current account exchange rates global imbalances

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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
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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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!]
    Other versions:
  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)
    Other versions:
  4. David Backus & Gian Luca Clementi, 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)
    Other versions:
  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. 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!]
  12. Richard H. Clarida, 2006. "G7 Current Account Imbalances: Sustainability and Adjustment," NBER Working Papers 12194, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. 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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  14. 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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  15. 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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  16. 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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  17. 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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  18. 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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Full references

Cited by:
(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. 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!]
  2. 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:
  3. 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!]
  4. Mendoza, Enrique G & Quadrini, Vincenzo & Ríos-Rull, José-Víctor, 2007. "Financial Integration, Financial Deepness and Global Imbalances," CEPR Discussion Papers 6149, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  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. 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!]
  7. 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!]
  8. Pierpaolo Benigno, 2006. "Are Valuation Effects Desirable from a Global Perspective?," NBER Working Papers 12219, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Gian Maria Milesi-Ferretti & Philip R. Lane, 2007. "Europe and Global Imbalances," IMF Working Papers 07/144, International Monetary Fund. [Downloadable!]
    Other versions:
  10. 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)
  11. Marques, Luis B, 2007. "Welfare Implications of Exchange Rate Changes," MPRA Paper 5721, University Library of Munich, Germany. [Downloadable!]
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