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External imbalances and the US current account: how supply-side changes affect an exchange rate adjustment

  • Engler, Philipp
  • Fidora, Michael
  • Thimann, Christian

The 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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Paper provided by European Central Bank in its series Working Paper Series with number 0761.

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Date of creation: Jun 2007
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Handle: RePEc:ecb:ecbwps:20070761
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  12. Irving B. Kravis & Robert E. Lipsey, 1988. "National Price Levels and the Prices of Tradables and Nontradables," NBER Working Papers 2536, National Bureau of Economic Research, Inc.
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  14. Mario Marazzi & Nathan Sheets & Robert J. Vigfusson & Jon Faust & Joseph Gagnon & Jaime Marquez & Robert F. Martin & Trevor Reeve & John Rogers, 2005. "Exchange rate pass-through to U.S. import prices: some new evidence," International Finance Discussion Papers 833, Board of Governors of the Federal Reserve System (U.S.).
  15. Catherine L. Mann, 2003. "Globalization of IT Services and White Collar Jobs: The Next Wave of Productivity Growth," Policy Briefs PB03-11, Peterson Institute for International Economics.
  16. Goldstein, Morris & Officer, Lawrence H, 1979. "New Measures of Prices and Productivity for Tradable and Nontradable Goods," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 25(4), pages 413-27, December.
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