Journal Article

Current account adjustment with high financial integration: a scenario analysis

Abstract: 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.

Keywords: Balance of trade; Foreign exchange; International trade;

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Economic Review

Publication Date: 2006

Pages: 31-45