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Using external sustainability to forecast the dollar

Listed author(s):
  • Ellen E. Meade
  • Charles P. Thomas

The sizable run-up in U.S. external debt over the 1980s has prompted many to ask whether continued current account deficits of the magnitude witnessed can be sustained. In several recent papers, different authors have concluded that a given path of the dollar is unsustainable. The conclusion drawn in these earlier papers does not allow for the substantial uncertainty that surrounds this issue, however. There is uncertainty about the estimated model of the U.S. current account that is used to generate the net demand for foreign assets for a given path of the dollar, about the preferences of foreign investors for U.S. assets, and about the mechanics of exchange rate determination that yields a particular path for the dollar. ; In this paper, we develop a way to explicitly address these sources of uncertainty. We find that for any given assumption about foreign preferences or the willingness of foreigners to supply net capital, there is a range of sustainable exchange rates. Moreover, that range of sustainable exchange rates varies considerably with changes in the assumption about foreign preferences. Using our framework, we can recast the earlier studies in terms of the likelihood that particular levels of the dollar would be consistent with sustainability.

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File URL: http://www.federalreserve.gov/pubs/ifdp/1991/398/default.htm
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File URL: http://www.federalreserve.gov/pubs/ifdp/1991/398/ifdp398.pdf
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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 398.

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Date of creation: 1991
Handle: RePEc:fip:fedgif:398
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  1. Boughton, James M., 1987. "Tests of the performance of reduced-form exchange rate models," Journal of International Economics, Elsevier, vol. 23(1-2), pages 41-56, August.
  2. Diebold, Francis X. & Nason, James A., 1990. "Nonparametric exchange rate prediction?," Journal of International Economics, Elsevier, vol. 28(3-4), pages 315-332, May.
  3. Jaime R. Marquez & Neil R. Ericsson, 1990. "Evaluating the predictive performance of trade-account models," International Finance Discussion Papers 377, Board of Governors of the Federal Reserve System (U.S.).
  4. Hali J. Edison, 1983. "The rise and fall of sterling: testing alternative models of exchange rate determination," International Finance Discussion Papers 224, Board of Governors of the Federal Reserve System (U.S.).
  5. Michael P. Dooley & Peter Isard, 1979. "The portfolio-balance model of exchange rates," International Finance Discussion Papers 141, Board of Governors of the Federal Reserve System (U.S.).
  6. Fukuda, Shin-ichi & Hoshi, Takeo & Ito, Takatoshi & Rose, Andrew, 2006. "International Finance," Journal of the Japanese and International Economies, Elsevier, vol. 20(4), pages 455-458, December.
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