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Current account adjustment with high financial integration: a scenario analysis

  • Michele Cavallo
  • Cédric Tille

A narrowing of the U.S. current account deficit through exchange rate movements is likely to entail a substantial depreciation of the dollar. We assess how the adjustment is affected by the high degree of international financial integration, with exchange rate movements having a direct valuation impact on international assets and liabilities. In particular, a dollar depreciation generates a capital gain for the United States by boosting the value of its assets that are denominated in foreign currencies. We consider an adjustment scenario in which the U.S. net external debt is held constant. One 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 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 are affected.

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Article provided by Federal Reserve Bank of San Francisco in its journal Economic Review.

Volume (Year): (2006)
Issue (Month): ()
Pages: 31-45

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Handle: RePEc:fip:fedfer:y:2006:p:31-45
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  1. Kenneth Rogoff & William Brainard & George Perry, . "Global Current Account Imbalances and Exchange Rate Adjustments," Working Paper 33687, Harvard University OpenScholar.
  2. Pierre-Olivier Gourinchas & Hélène Rey, 2005. "International Financial Adjustment," International Finance 0505004, EconWPA.
  3. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2005. "A Global Perspective on External Positions," CEPR Discussion Papers 5234, C.E.P.R. Discussion Papers.
  4. Michele Cavallo & Cedric Tille, 2006. "Could capital gains smooth a current account rebalancing?," 2006 Meeting Papers 252, Society for Economic Dynamics.
  5. Maurice Obstfeld & Kenneth Rogoff, 2007. "The Unsustainable U.S. Current Account Position Revisited," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 339-376 National Bureau of Economic Research, Inc.
  6. Linda S. Goldberg & Cedric Tille, 2005. "Vehicle Currency Use in International Trade," NBER Working Papers 11127, National Bureau of Economic Research, Inc.
  7. Maurice Obstfeld, 2004. "External Adjustment," NBER Working Papers 10843, National Bureau of Economic Research, Inc.
  8. 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.
  9. Blanchard, Olivier & Giavazzi, Francesco & Sá, Filipa, 2005. "The US Current Account and the Dollar," CEPR Discussion Papers 4888, C.E.P.R. Discussion Papers.
  10. David Backus & Espen Henriksen & Frederic Lambert & Chris Telmer, 2005. "Current Account Fact and Fiction," 2005 Meeting Papers 115, Society for Economic Dynamics.
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