External Imbalances and the US Current Account: How Supply-Side Changes Affect an Exchange Rate Adjustment

43 Pages Posted: 28 Jun 2007

See all articles by Philipp Engler

Philipp Engler

International Monetary Fund (IMF)

Michael Fidora

European Central Bank (ECB)

Christian Thimann

AXA Group

Date Written: June 2007

Abstract

The influential work of Obstfeld and Rogoff argues that a closing-up of the US current account deficit involves a large exchange rate adjustment. However, the Obstfeld-Rogoff model works exclusively via demand-side channels and abstracts from possible supply-side changes. We extend the framework to allow for endogenous supply-side changes and show that this fundamentally alters the mechanism of the adjustment process. Allowing for such an extension attenuates quite significantly the implied exchange rate adjustment. The paper also provides some empirical evidence of variations in the supply-side structure and correlations with the exchange rate and the current account. The policy implications are that measures to foster a supply-side reaction would facilitate the external adjustment by alleviating an exclusive reliance on demand and exchange rate changes, with the latter being potentially destabilising for the global financial system.

Keywords: Global imbalances, US current account deficit, dollar adjustment, sectoral

JEL Classification: E2, F32, F41

Suggested Citation

Engler, Philipp and Fidora, Michael and Thimann, Christian, External Imbalances and the US Current Account: How Supply-Side Changes Affect an Exchange Rate Adjustment (June 2007). ECB Working Paper No. 761, Available at SSRN: https://ssrn.com/abstract=989725 or http://dx.doi.org/10.2139/ssrn.989725

Philipp Engler (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Michael Fidora

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 5713 (Phone)

Christian Thimann

AXA Group ( email )

25 avenue Matignon
Paris, 75008
France

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