Frank A. Schmid

English

Research Papers in Economics

August 2003
InternationalEconomicTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
Is the Current Account
Deficit Weighing on
the Dollar?
T
he United States has run current account deficits
since the early 1990s. But only in the last couple
of years have these deficits assumed extraordinary
proportions. From the second quarter of 2002 through
the first quarter of 2003, the U.S. current account deficit
has been 4.8 percent of GDP.
A country with a current account deficit has more
imports of goods and services than exports and net receipts
of transfers from abroad. Any current account deficit must
be matched by a financial and capital account surplus.
In other words, a country with a current account deficit
surrenders claims on future income—such as physical
assets, stocks, and bonds—to foreigners. The ongoing
U.S. current account deficit of 4.8 percent of GDP trans-
lates into an average of $1.6 billion in net capital imports
per business day. That is, foreign investors have been
accumulating U.S. assets at an unusually high rate.
Foreign investors might become wary of holding
increasingly larger portions of their wealth in U.S. assets.
In order to promote continued investment in the United
States, U.S. assets would then have to become more attrac-
tive. One way of attracting foreign investment is to lower
the price of the asset in foreign currency terms. A decline
in the foreign exchange value of the dollar would do just
that. Therefore, a large current account deficit might be
expected to depress the value of the dollar over time. But
what about the current account deficit?
Caroline Freund studied 25 episodes of current account
reversals of industrialized countries during the period
1980-97.1 The study covers only cases in which a current
account deficit that peaks at 2 percent of GDP or more
subsequently reverses direction by at least 2 percent of
GDP within three years. The author finds that, when a
current account deficit approaches 5 percent of GDP, that
country’s real exchange rate—the exchange rate weighted
by trading partners and adjusted for differences in the
rates of inflation between that country and its trading
partners—starts depreciating. Typically, the current account
starts to reverse toward balance one year after the onset
of the currency depreciation. Three years after the peak
deficit, most of the countries show a nearly complete
reversal to a balanced current account.
The chart shows the real effective U.S. dollar exchange
rate and the U.S. current account balance as a percentage
of GDP for the period 1998:Q1 through 2003:Q1. In spite
of a current account deficit in the neighborhood of 4 per-
cent of GDP, the real effective value of the U.S. dollar
appreciated considerably from 2000 to early 2002; subse-
quently, the dollar started declining amidst further widen-
ing of the current account deficit (to about 5 percent of
GDP). If the United States follows the typical pattern of
current account reversals, then we can expect that during
the next three years the real effective exchange rate will
keep depreciating and the current account deficit will
swing back to balance.
—Frank A. Schmid
1 Freund, Caroline L. “Current Account Adjustment in Industrialized Countries.”
International Finance Discussion Paper No. 692, Board of Governors of the
Federal Reserve System, December 2000. www.federalreserve.gov/pubs/ifdp/
2000/692/ifdp692.pdf.
Available on the web at research.stlouisfed.org
1.1
1.15
1.2
1.25
1.3
1.35
1.4
1998 1999 2000 2001 2002 2003
–6
–5
–4
–3
–2
–1
0
Current Account Balance as a Percent of GDP (Right Scale)
Real Effective Exchange Rate (Index, 1995=1)
Current Account Balance and Exchange Rate
NOTE: Quarterly observations: first observation, 1998:Q1;
last observation, 2003:Q1.
SOURCE: Bureau of Economic Analysis (Current Account
Balance and GDP), International Monetary Fund (Real
Effective Exchange Rate). 

Is the current account deficit weighing on the dollar?

http://research.stlouisfed.org/publications/iet/20030801/cover.pdf

Is the current account deficit weighing on the dollar?

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics