Global Imbalances and Exchange Rates: Welfare and Policy Implications

Abstract

As international trade and financial flows have increased, so have the so-called ‘global imbalances’, that is, the large and persistent trade and current account imbalances, including the current account deficit of the United States and the counterpart rise in the surpluses of East Asian nations (most notably, China and Japan). The natural question that arises is whether such persistent current account imbalances could pose an economic problem in themselves and whether the imbalances are sustainable. Deeply imbedded in the sustainability issue is the debate on the need for, and the feasibility of, the correction of current account positions. Some contend that the current account imbalances should and can be corrected, for instance, by way of policy-induced changes in the terms of trade (or real exchange rate) accompanied by deliberate changes in the exchange rate. Behind this view is the implicitly assumed adjustment mechanism that a decrease in the relative international price of exportables (that is, a real depreciation or devaluation) results in increased net exports.

This work was partly conducted while the author was visiting the Center on Japanese Economy and Business, Columbia Business School. Part of this chapter was presented at the International Conference on Trade, Regional and Industrial Economics held at Tamkang University in March 2009.