Working Paper: CEPR ID: DP7325
Authors: Karlygash Kuralbayeva; David Vines
Abstract: This paper extends the analysis of the forthcoming fall in the dollar by Blanchard, Giavazzi and Sà 2005), using a model which incorporates forward-looking consumers. It provides additional underpinnings for the idea of a rapid adjustment in the value of the dollar. We analyze what will happen to the dollar value when forward-looking consumers, in anticipation of the reduction in the current account deficit, cut their consumption. We show that the real interest rate must fall as a result, and that this causes the exchange rate to fall more initially. However we also show that the interest rate does not fall greatly initially, and so that these effects are not large. But they add to pressures causing a rapid fall in the dollar.
Keywords: Imperfect substitutability; Net foreign assets; Valuation effects
JEL Codes: F32; F41; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Anticipated reduction in real income due to current account adjustment (F32) | Cut in consumption (E21) |
| Cut in consumption (E21) | Fall in real interest rate (E43) |
| Fall in real interest rate (E43) | More significant immediate depreciation of the exchange rate (F31) |
| Anticipated reduction in real income due to current account adjustment (F32) | More significant immediate depreciation of the exchange rate (F31) |
| Fall in real interest rate (E43) | Initial fall in the interest rate (E43) |