Working Paper: CEPR ID: DP4888
Authors: Olivier Blanchard; Francesco Giavazzi; Filipa Sa
Abstract: There are two main forces behind the large US current account deficits. First, an increase in the US demand for foreign goods. Second, an increase in the foreign demand for US assets. Both forces have contributed to steadily increasing current account deficits since the mid-1990s. This increase has been accompanied by a real dollar appreciation until late 2001, and a real depreciation since. The depreciation has accelerated recently, raising the questions of whether and how much more is to come, and if so, against which currencies, the euro, the yen, or the renminbi.Our purpose in this paper is to explore these issues. Our theoretical contribution is to develop a simple portfolio model of exchange rate and current account determination, and to use it to interpret the past and explore alternative scenarios for the future. Our practical conclusions are that substantially more depreciation is to come, surely against the yen and the renminbi, and probably against the euro.
Keywords: current account; dollar; exchange rate; portfolio models
JEL Codes: E30; F21; F32; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| US demand for foreign goods (F10) | US current account deficit (F32) |
| Foreign demand for US assets (E41) | US current account deficit (F32) |
| Shifts in relative demand for US goods and assets (F29) | Exchange rate (F31) |
| Higher net debt (G32) | Lower exchange rate (F31) |
| Depreciation of the dollar (F31) | Improved net debt position (G32) |
| Depreciation of the dollar (F31) | Trade balance improvements (F14) |
| Depreciation of the dollar (F31) | Asset revaluation (G32) |