EXCHANGE RATES AND
EXTERNAL ADJUSTMENT
Gian Maria Milesi-Ferretti
International Monetary Fund
Global imbalances have declined…
4
Global Imbalances
(percent of world GDP)
3
2
1
0
-1
-2
-3
2000
2001
US
JPN
2002
2003
Eur surplus
2004
CHN
2005
EMA
2006
OIL
2007
ROW
2008
2009
Eur deficit
2010
2011
Discrepancy
.4
How did the adjustment take place?
Primarily through changes in demand
CHN
.2
BLR
PER
IND
LBN
ARG
IDN
SLKURU
CHLDR
MOR
BRA
TUN PHL
COL PAK
HKG MYS POL
AUS
ISR
CRI SAF
CAN THA KOR
TAI GTM
TUR
SWI
GER
NOR
LUX
SVKCYP
MEX
BEL
SWE
FRA
CZE
AUT
RUS
NLD
PRT
US
NZE SER
FIN
JPN
ITAUK
ELS
DEN
SLV
ESP
GRE
ROM
UKR CRO HUN
BLG
-.2
0
SGP
IRE
LIT
EST
-.4
ICE
LVA
-.1
0
.1
.2
change in CA balance, 2007-10
.3
.3
…and changes in output
LBN
IND
URU
PER
BLR
SLK
IDN
DRARG
SGP
MOR
BRA
TUN PHL
POL
MYSTAI PAK
ISR
KOR
CHL THA COL GTM
AUS
HKG
CRISVK
SAF
TUR
SER
SWI
CYP
CAN LUX
RUS
CZE
MEX
BEL
US
AUT
GER
NLD
SWE
NOR
FRA PRT ELS NZE
ROM
JPN
SLVESP
DEN
FIN UK
GRE
ITA
CRO HUN
-.1
0
.1
.2
CHN
UKR
BLG
ICE
IRE
LIT
-.2
EST
LVA
-.1
0
.1
.2
change in CA balance, 2007-10
.3
10
Some (weak) negative relation between REER
and CA changes for non-peggers…
ROM
5
ICE
HUN
SWI
NZE
SAF
AUS
CRI
PAK
-5
0
US
UKRPOL
KOR
PHL
GTM
CZE
COL
TUR
UK
MYS
RUS
JPN
ISR
IDN
ARG
MEX
THA
NOR CHL
IND
SWE PER
CAN
MOR
CHN
URU
BRA
SLK
-10
SGP
-15
TUN
-40
-20
0
20
Change in REER, 2011 vs 2005-08
40
30
…but positive relation between CA changes and
REER changes for peggers
BLG
20
LVA
EST
LIT
10
BLR
IRE
0
TAI
HKG
CRO
DEN
SLV
ESP
GRE
SVK
PRTBEL
NLD
AUT
ITA
GERFRA
LUX
FIN
CYP
-10
ELS
-10
0
10
Change in REER, 2011 vs 2005-08
20
…so real exchange rates don’t matter
for trade balances?



Yes they do….
…but many other factors at play
Key example: terms of trade (which makes CA and
REER move in the same direction)
Assessing real exchange rates



Difficult to predict real exchange rates
Eminently endogenous variable, complex set of
macro, financial and trade factors
Analyzed in conjunction with external balances
(current account/capital flows, evolution of net
foreign assets)
Assessing real exchange rates (II)

IMF approach to exchange rate and CA assessment
 Broad
bilateral/multilateral surveillance context
 Quantitative assessments
Price-based (real exchange rate dynamics)
 Current account balance-based (CA fundamentals and NFA
dynamics)



Now re-cast more generally in the context of an
External Stability Report
Still, very complex endeavor! Some examples:
Assessing REER and CA


REER-based methods (fundamentals such as TT, NFA
position, relative productivity/level of development
etc)
CA (“MB” approach, now “EBA”):
 empirical
relation of CA with macro, financial, and
structural determinants, plus policy variables
 Assessment based on ‘desirable’values for policy
variables

ES: is the predicted CA balance consistent with
broad stabilization of the NFA position?
Assessing real exchange rates and the CA: China




Large CA surplus (now considerably narrower)
Substantial reserve accumulation
(Mostly) closed capital account.
Two stories:
 Export-led


growth
High savings due to domestic distortions (lack of social
safety net, financial underdevelopment etc)
In both cases, REER “depreciated” and must
eventually adjust, but “centrality” of exchange rate
and need for policy adjustment different
Assessing real exchange rates and CA:
the United States



US CA deficit much narrower than pre-crisis…
…but still >3 percent despite sizable output gap
But REER is at close to historical minima. Hard problem!
135
125
115
105
95
85
75
The dollar's real effective
exchange rate
FRB index
(all
currencies)
Assessing real exchange rates and CA:
EMs and inflows





Strong terms of trade gains in many EMs
High capital inflows, rapid growth of domestic
demand
Appreciating REER, increasing CA deficit (despite TT
gains in commodity exporters)
Both structural and cyclical elements at play in
explaining inflows, REER
Risk of reversals, impact on non-commodity sector
Assessing real exchange rates and CA:
EMs and inflows (II)

Are low interest rates/QE to blame?
 Weak
US economy, financial turmoil in Europe bad for
everyone
 US portfolio outflows much weaker in 2010-11 than
pre-crisis
 However, differences in degree of openness of capital
account can imply more flows channeled to emerging
economies with more open and developed debt
markets
Assessing real exchange rates EMs and
inflows (III)

Reversals bound to happen, essential to have
defenses
 Appropriate
macro stance, with room to respond to
shocks
 Reserves
 Avoid currency/maturity mismatches
 Use macro-prudential tools and K-controls where
needed to try to lengthen maturity of inflows
The need for global rebalancing

Global rebalancing essential

Sustaining world growth


Reducing external vulnerabilities


Liquidity trap and risks of insufficient global demand
Legacy of crisis still with us for years to come
Multilateral approach needed

Adjustment cannot rely exclusively on demand compression in
deficit countries
How to go about it?
 Target
structural and policy distortions (macro, financial,
trade)
 …but narrow trade lens inappropriate given
complexity of underlying factors
 Real exchange rates need to adjust and will adjust,
whether through nominal rates or prices
 Be mindful of cyclical vs structural considerations
 “second-best world”