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

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Listed:
  • Hilary Croke
  • Steven B. Kamin
  • Sylvain Leduc

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.

Suggested Citation

  • Hilary Croke & Steven B. Kamin & Sylvain Leduc, 2005. "Financial market developments and economic activity during current account adjustments in industrial economies," International Finance Discussion Papers 827, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:827
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    References listed on IDEAS

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    1. 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.
    2. Gian Maria Milesi Ferretti & Assaf Razin, 2000. "Current Account Reversals and Currency Crises: Empirical Regularities," NBER Chapters,in: Currency Crises, pages 285-323 National Bureau of Economic Research, Inc.
    3. 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 577-577.
    4. Sebastian Edwards, 2004. "Thirty Years of Current Account Imbalances, Current Account Reversals, and Sudden Stops," IMF Staff Papers, Palgrave Macmillan, vol. 51(s1), pages 1-49, June.
    5. 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.).
    6. 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.
    7. Krugman, Paul & Taylor, Lance, 1978. "Contractionary effects of devaluation," Journal of International Economics, Elsevier, vol. 8(3), pages 445-456, August.
    8. 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.
    9. Catherine L. Mann, 1999. "Is the U.S. Trade Deficit Sustainable?," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 47.
    10. Freund, Caroline, 2005. "Current account adjustment in industrial countries," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1278-1298, December.
    11. J. Saul Lizondo & Peter J. Montiel, 1989. "Contractionary Devaluation in Developing Countries: An Analytical Overview," IMF Staff Papers, Palgrave Macmillan, vol. 36(1), pages 182-227, March.
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    Keywords

    Balance of payments ; Balance of trade;

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