Asset prices, exchange rates and the current account

Abstract

In 2007 all ECB publications feature a motif taken from the €20 banknote. WO R K I N G PA P E R S E R I E S N O 7 9 0 / A U G U S T 2 0 0 71 We are grateful to Harald Uhlig for helpful suggestions and advice at various stages of this paper, and to Thierry Bracke, Matthieu Bussière, Mike Clements, Valentina Corradi, Luca Dedola, Michael Ehrmann, Martin Ellison, Charles Engel, Mathias Hoffmann, Steven Kamin, Gian Maria Milesi-Ferretti, Gernot Müller, John Rogers, Rasmus Rüffer, Roland Straub, Ilias Tsiakas, Jeromin Zettelmeyer and seminar Abstract This paper analyses the role of asset prices in comparison to other factors, in particular exchange rates, as a driver of the US trade balance. It employs a Bayesian structural VAR model that requires imposing only a minimum of economically meaningful sign restrictions. We …nd that equity market shocks and housing price shocks have been major determinants of the US current account in the past, accounting for up to 32% of the movements of the US trade balance at a horizon of 20 quarters. By contrast, shocks to the real exchange rate have been much less relevant, explaining less than 7% and exerting a more temporary e¤ect on the US trade balance. Our …ndings suggest that sizeable exchange rate movements may not necessarily be a key element of an adjustment of today's large current account imbalances, and that in particular relative global asset price changes could be a more potent source of adjustment.Keywords: current account; global imbalances; exchange rates; Bayesian VAR; sign restrictions.JEL Classi…cation: F32; F40; C30. ECB Working Paper Series No 790 August 2007Non-technical summaryThe debate about the origins and causes of today's large global current account imbalances continues to be highly contoversial. One camp of this debate points at the US as the culprit, and in particular at its low private and public savings, while others argue that it is a "saving glut"in Asia and among oil-exporting countries that has been the key driver of rising current account dispersions. Moreover, a number of scholars and policy makers have given central stage to the need for a large exchange rate depreciation to increase US exports and, hence, reduce its trade and current account de…cits. In general, however, there is no clear-cut empirical evidence so far showing that exchange rates have been a major driver of current account positions for advanced economies.By contrast, other scholars have pointed at the relevance of asset prices for the current account determination and adjustment through wealth e¤ects. The underlying logic is that a rise in asset prices (in particular if it is expected to be permanent) increases expected income of households and, therefore, increases their consumption.Indeed, one striking feature of the global economy over the past 15 years has been the pronounced cycles and booms in asset prices. US equity prices have risen by almost 500% and non-US stock prices by more than 200% between 1990 and 2000, before losing about one third of their value in the ...

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“…Consequently, an NF shock can be regarded as one shock that improves the trade balance after the crisis. This result is consistent with that reported by Fratzscher et al (2010).…”

“…Furthermore, this empirical result is in line with those reported by Fratzscher et al (2010), which indicates that the large exchange rate movements might not be the key element of an adjustment of the current account. That is to say, even though 9) Malaysia is a petroleum-exporting country.…”

“…Especially, Fisher (2006) and Letendre and Luo (2007) show that the productivity shock arising from the capital goods sector explains a large share of domestic and foreign macroeconomic variables. Fratzscher et al (2010), which emphasizes consumption instead of investment as a wealth effect. In addition, because NF shocks pass through the balance sheet of the private sector, they take some time to affect investment.…”

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“…23 This assessment is also consistent with a number of studies that use structural VARs to identify monetary and real shocks. See Bems, Dedola and Smets (2007), Bracke and Fidora (2008), and Fratzscher, Juvenal and Sarno (2007). 24 The "Great Stability" and "Great Moderation" are terms used to describe the combination of low in ation and reduced output volatility All of these probably contributed to some degree.…”

Asset Prices and Current Account Fluctuations in G-7 Economies

“…This methodology not only requires imposing a relatively small and intuitive number of identi…cation restrictions, but importantly it also allows us to distinguish asset price shocks from other types of shocks, such as to technology, monetary policy and government spending. Our empirical implementation follows closely that of Fratzscher and Straub (2008), as well as that of Fratzscher, Juvenal and Sarno (2007), who test for the e¤ect of equity market shocks, housing price shocks and exchange rate shocks on the trade balance of the United States. The latter paper shows that equity market shocks and housing price shocks have been important drivers explaining more than 30 percent of the variation of the US trade balance, whereas exchange rates account for a much smaller share.…”