Financial Market Developments and Economic Activity During Current Account Adjustments in Industrial Economies

57 Pages Posted: 30 Mar 2005

See all articles by Steven B. Kamin

Steven B. Kamin

Board of Governors of the Federal Reserve System

Sylvain Leduc

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Hilary Croke

U.S. Board of Governors of the Federal Reserve

Date Written: February 2005

Abstract

Much has been written about prospects for U.S. current account adjustment, including the possibility of what is sometimes referred to as a disorderly correction: a sharp fall in the exchange rate that boosts interest rates, depresses stock prices, and weakens economic activity. This paper assesses some of the empirical evidence bearing on the likelihood of the disorderly correction scenario, drawing on the experience of previous current account adjustments in industrial economies. We examined the paths of key economic performance indicators before, during, and after the onset of adjustment, building on the analysis of Freund (2000).

We found little evidence among past adjustment episodes of the features highlighted by the disorderly correction hypothesis. Although some episodes in our sample experienced significant shortfalls in GDP growth after the onset of adjustment, these shortfalls were not associated with significant and sustained depreciations of real exchange rates, increases in real interest rates, or declines in real stock prices. By contrast, it was among the episodes where GDP growth picked up during adjustment that the most substantial depreciations of real exchange rates occurred. These findings do not preclude the possibility that future current account adjustments could be disruptive, but they weaken the historical basis for predicting such an outcome.

Keywords: Current account deficit, trade deficit, exchange rate adjustment, disorderly correction

JEL Classification: F32, F41

Suggested Citation

Kamin, Steven B. and Leduc, Sylvain and Croke, Hilary, Financial Market Developments and Economic Activity During Current Account Adjustments in Industrial Economies (February 2005). FRB International Finance Discussion Paper No. 827. Available at SSRN: https://ssrn.com/abstract=678945 or http://dx.doi.org/10.2139/ssrn.678945

Steven B. Kamin (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Sylvain Leduc

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Hilary Croke

U.S. Board of Governors of the Federal Reserve ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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