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International Financial Adjustment
with Helene Rey (Princeton University)
A pdf version of the paper is available (v.02/07/05).
Here is the 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.
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