Currency Appreciation and Current Account Adjustment

Global current account imbalances, more specifically the large deficit in the United States and the surplus in China and some other Asian economies, continue to attract considerable attention both among policy makers and academics. While the academic literature has focused predominantly on the sustainability of the imbalance and on the exchange-rate consequences of its elimination, many policy makers have focused narrowly on the need for a renminbi revaluation. In the absence of this, the US congress has threatened to impose trade restrictions as a way to generate the equivalent type of relative price adjustment that would be caused by such an appreciation. In view of the intense interest that current account adjustment has raised, a natural question to ask is whether, in the particular context of the policy discussion taking place, exchange rate appreciation is either effective in achieving its goal or a desirable part of an overall adjustment policy. Our view is that this question can be addressed only within a multi-country general equilibrium context. For example, many early papers simply used estimates of trade-balance equations for the US to ask what change in the real exchange rate of the dollar would be consistent with and adjustment of a given size in the current account, assuming exogenous paths for domestic and foreign income (the other variables typically included in such equations). The ’required’ change in the real exchange rate was then mechanically distributed