Working Paper: NBER ID: w11771
Authors: Michael P. Dooley; David Folkerts-Landau; Peter M. Garber
Abstract: In this paper we examine the behavior of interest rates and exchange rates following a variety of shocks to the international monetary system. Our analysis suggests that real interest rates in the US and Europe will remain low relative to historical experience for an extended period but converge slowly toward normal levels. During this adjustment interval, the US absorbs a disproportionate share of world savings. After a substantial initial appreciation of floating currencies relative to the dollar, the dollar and other floating currencies remain constant relative to each other. An improvement in the investment climate in Europe during the adjustment period would generate an immediate depreciation of the euro relative to the dollar. In real terms, the dollar and the floating currencies will eventually have to depreciate relative to the managed currencies. But most of the adjustment in the US trade account will come as US absorption responds to increases in real interest rates.
Keywords: Interest Rates; Exchange Rates; International Adjustment
JEL Codes: F02; F32; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Asian savings exports (F14) | US real interest rates (E43) |
| Asian savings exports (F14) | Eurozone real interest rates (E43) |
| US and Eurozone real interest rates (E43) | convergence towards normal levels (F62) |
| Floating currencies appreciation (F31) | US dollar stabilization (F31) |
| Investment climate improvement in Europe (O52) | euro depreciation against dollar (F31) |
| US absorption increase (E20) | US trade account adjustments (F32) |
| US real interest rates (E43) | dollar depreciation against managed currencies (F31) |