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Adjustment in the World Economy

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  • Paul Krugman

Abstract

There is a widespread view that world payments imbalances can be remedied through increased demand in surplus countries and reduced demand in deficit countries, without any need for real exchange rate changes. In fact shifts in demand and real exchange rate adjustment are necessary couplets, not substitutes. The essential reason for this complementarity is that a much higher fraction of a marginal dollar of US than of foreign spending falls on US output. As a result, a redistribution of world spending away from the US leads to an excess supply of US goods unless accompanied by a decline in their relative price. Although some economists believe that the integration of world capital markets somehow eliminates this problem, this is a fallacy that confuses accounting identities with behavior. The paper also addresses a number of relates issues, such as the role of budget deficits in determining domestic demand and the effectiveness of nominal exchange rates changes in producing real depreciation.

Suggested Citation

  • Paul Krugman, 1987. "Adjustment in the World Economy," NBER Working Papers 2424, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2424
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    References listed on IDEAS

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    1. Morris Goldstein & Mohsin S. Khan, 2017. "Income and Price Effects in Foreign Trade," World Scientific Book Chapters, in: TRADE CURRENCIES AND FINANCE, chapter 1, pages 3-81, World Scientific Publishing Co. Pte. Ltd..
    2. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-329, June.
    3. Paul R. Krugman, 1985. "Is the strong dollar sustainable?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 103-155.
    4. Olivier J. Blanchard & Lawrence H. Summers, 1984. "Perspectives on High World Real Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 273-334.
    5. Gordon, Robert J., 1986. "U. S. Fiscal Deficits and the World Imbalance of Payments," Hitotsubashi Journal of Economics, Hitotsubashi University, vol. 27(Special I), pages 7-41, January.
    6. Paul R. Krugman & Richard E. Baldwin, 1987. "The Persistence of the U.S. Trade Deficit," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 18(1), pages 1-56.
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    Cited by:

    1. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2002. "External wealth, the trade balance, and the real exchange rate," European Economic Review, Elsevier, vol. 46(6), pages 1049-1071, June.
    2. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2001. "The external wealth of nations: measures of foreign assets and liabilities for industrial and developing countries," Journal of International Economics, Elsevier, vol. 55(2), pages 263-294, December.
    3. Jon Cockerline & John F. Helliwell & Robert Lafrance, 1990. "Multicountry modeling of financial markets," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 305-363.
    4. Frankel, Jeffrey, 2004. "On the Renminbi: The Choice between Adjustment under a Fixed Exchange Rate and Adustment under a Flexible Rate," Working Paper Series rwp04-037, Harvard University, John F. Kennedy School of Government.
    5. Babacar XSENE, 2005. "Impact du fardeau virtuel de la dette sur le taux de change réel d'équilibre des pays en développement," Macroeconomics 0501014, University Library of Munich, Germany.
    6. Charles Bronowski & Juann H. Hung, 2002. "Modeling the U.S. Current Account as the Savings-Investment Balance: Technical Paper 2002-5," Working Papers 14224, Congressional Budget Office.
    7. Michele Bullock & Stephen Grenville & Geoffrey Heenan, 1993. "The Exchange Rate and the Current Account," RBA Annual Conference Volume (Discontinued), in: Adrian Blundell-Wignall (ed.),The Exchange Rate, International Trade and the Balance of Payments, Reserve Bank of Australia.
    8. Jeffrey Frankel, 2005. "On the renminbi," CESifo Forum, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 6(03), pages 16-21, October.
    9. Peter Hooper, 1989. "Exchange rates and U.S. external adjustment in the short run and the long run," International Finance Discussion Papers 346, Board of Governors of the Federal Reserve System (U.S.).
    10. Anjan Panday, 2014. "Monetary Integration between India and Nepal," South Asia Economic Journal, Institute of Policy Studies of Sri Lanka, vol. 15(2), pages 199-224, September.
    11. Peter Hooper, 1989. "Macroeconomic policies, competitiveness, and U.S. external adjustment," International Finance Discussion Papers 347, Board of Governors of the Federal Reserve System (U.S.).
    12. Juann H. Hung & Edward N. Gamber, 2010. "An Absorption Approach to Modeling the US Current Account," Review of International Economics, Wiley Blackwell, vol. 18(2), pages 334-350, May.

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