Working Paper: CEPR ID: DP4923
Authors: Pierre-Olivier Gourinchas; Hélène Rey
Abstract: The Paper proposes a unified framework to study the dynamics of net foreign assets and exchange rate movements. We show that deteriorations in a country?s net exports or net foreign asset position have to be matched either by future net export growth (trade adjustment channel) or by future increases in the returns of the net foreign asset portfolio (hitherto unexplored financial adjustment channel). Using a newly constructed data set on US gross foreign positions, we find that stabilizing valuation effects contribute as much as 31% of the external adjustment. Our theory also has asset-pricing implications. Deviations from trend of the ratio of net exports to net foreign assets predict net foreign asset portfolio returns one quarter to two years ahead and net exports at longer horizons. The exchange rate affects the trade balance and the valuation of net foreign assets. It is forecastable in and out of sample at one quarter and beyond. A one standard deviation decrease of the ratio of net exports to net foreign assets predicts an annualized 4% depreciation of the exchange rate over the next quarter.
Keywords: Exchange rates; External adjustment; Meese-Rogoff; Net foreign assets; Valuation
JEL Codes: F31; F32; F37
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Deterioration in the ratio of net exports to net foreign assets (F32) | annualized depreciation of the exchange rate (F31) |
| Deterioration in the ratio of net exports to net foreign assets (F32) | future net export growth (F17) |
| Deterioration in the ratio of net exports to net foreign assets (F32) | future returns on the US net foreign portfolio (F21) |
| Changes in the value of net foreign assets (F32) | international adjustment of the US (F32) |