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International Financial Adjustment

Author

Listed:
  • Pierre-Olivier Gourinchas

    (Economics Department, University of California, Berkeley)

  • Hélène Rey

    (Department of Economics & Woodrow Wilson School,, Princeton University)

Abstract
The paper proposes a unified framework to study the dynamics of net foreign assets and exchange rate movements. We show that deteriorations in a country's net exports or net foreign asset position have to be matched either by future net export growth (trade adjustment channel) or by future increases in the returns of the net foreign asset portfolio (hitherto unexplored financial adjustment channel). Using a newly constructed data set on US gross foreign positions, we find that stabilizing valuation effects contribute as much as 31% of the external adjustment. Our theory also has asset pricing implications. Deviations from trend of the ratio of net exports to net foreign assets predict net foreign asset portfolio returns one quarter to two years ahead and net exports at longer horizons. The exchange rate affects the trade balance and the valuation of net foreign assets. It is forecastable in and out of sample at one quarter and beyond. A one standard deviation decrease of the ratio of net exports to net foreign assets predicts an annualized 4% depreciation of the exchange rate over the next quarter.

Suggested Citation

  • Pierre-Olivier Gourinchas & Hélène Rey, 2005. "International Financial Adjustment," International Finance 0505004, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpif:0505004
    Note: Type of Document - pdf; pages: 47
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    References listed on IDEAS

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    More about this item

    Keywords

    Meese-Rogoff; external adjustment; net foreign assets; valuation effects; exchange rates;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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