We show that when one takes into account the global equilibrium ramifications of an unwinding of the US current account deficit, currently estimated at 5.4% of GDP, the potential collapse of the dollar becomes considerably larger (more than 50% larger) than our previous estimates (Obstfeld and Rogoff 2000a). That global capital markets may have deepened (as emphasized by US Federal Reserve Chairman Alan Greenspan) does not affect significantly the extent of dollar decline in the wake of global current account adjustment. Rather, the dollar adjustment to global current account rebalancing depends more centrally on the level of goods-market integration. Whereas the dollar’s decline may be benign as in the 1980s, we argue that the current conjuncture more closely parallels the early 1970s, when the Bretton Woods system collapsed. Finally, we use our model to dispel some common misconceptions about what kinds of shifts are needed to help close the US current account imbalance. Faster growth abroad helps only if it is relatively concentrated in nontradable goods; faster productivity growth in foreign tradable goods is more likely to exacerbate the US adjustment problem.
An eventual adjustment of the outsized US current account deficit is likely to have significant impact on global exchange rates unless it occurs only over a very long period. Policy responses aimed at reducing the risk of a recession are warranted, but they will not necessarily avoid the exchange rate adjustment.
The intertemporal approach views the current-account balance as the outcome of forward-looking dynamic saving and investment decisions. This paper, a chapter in the forthcoming third volume of the Handbook of International Economics, surveys the theory and empirical work on the intertemporal approach as it has developed since the early 1980s. After reviewing the basic one-good, representative- consumer model, the paper considers a series of extended models incorporating relative prices, complex demographic structures, consumer durables, asset-market incompleteness, and asymmetric information. We also present a variety of empirical evidence illustrating the usefulness of the intertemporal approach, and argue that intertemporal models provide a consistent and coherent foundation for open-economy policy analysis. As such, the intertemporal approach should supplant the expanded versions of the Mundell-Fleming IS-LM model that currently furnish the dominant paradigm used by central banks, finance ministries, and international economic agencies.
This paper develops an analytically tractable empirical model of investment and the current account, and applies it to data from the G-7 countries. This distinction between global and country-specific shock turns out to be quite important for explaining current account behavior; overall the model performs surprisingly well. One apparent puzzle, however, is that the current account responds by much less than investment to country-specific shocks, despite the near unit root behavior of these shocks. We show theoretically that this apparent anomaly can be explained if the shocks have very slow mean reversion.