Guest Contribution: “US Trade Deficit and Exchange Rates”

Today, we are fortunate to have Willem Thorbeck, Senior Fellow at the Japan Research Institute of Economics, Trade and Industry (RIETI) as a guest contributor. The opinions expressed are those of the author himself, and do not necessarily represent the views of RIETI or any other organizations to which the author is affiliated.

The US current account deficit increased from 2.1% of GDP in 2019 to 3.7% of GDP in 2020 to 4.8% of GDP in the first quarter of 2022. The Bureau of Economic Analysis stated that this increase is driven by the growing deficit in goods. . trade. Figure 1 shows the US trade deficit in goods.

Figure 1. The US Trade Deficit 2000-2022. source: United States Census Bureau.

The recent trade and current account deficits emerged in the context of a large US budget deficit, higher interest rates in the US compared to its trading partners, and an appreciation of the US dollar. In the 1980s, the United States also experienced large budget deficits, higher interest rates compared to its trading partners, and a rising dollar. In the 1980s, a strong dollar caused U.S. companies competing in the field of export and import to lose their price competitiveness. In 1985, the United States ran a trade and current account deficit of 3% of GDP.

The G5 countries (France, Germany, Japan, the United Kingdom, and the United States) were alarmed by these imbalances. To solve it, they reached the Plaza Accord in September 1985. The United States agreed to cut its budget deficit, America’s trading partners implemented stimulus policies, the five countries worked together to lower the value of the dollar, and everyone agreed to fight protectionism. The dollar actually fell and the current account of the United States reached equilibrium in 1991.

Estimating business flexibility

The exchange rate adjustments seem to have helped rebalance trade after the Plaza Accord. To check if they have that effect now, I appreciate the flexibility of US import and export. In previous work, Chen used dynamic ordinary least squares (DOLS) techniques to estimate the trade elasticity of US imports and exports during the first quarter period from 1975 to 2010. In his baseline specification, he reported an exchange rate elasticity of -0.45 and an income elasticity of 2.6 for imports Commodities excluding oil. For exports of goods excluding agriculture, he found exchange rate elasticities of 0.6 and income elasticities of 1.9.

I estimate total import and export elasticities using data on imports of goods excluding oil and commodity exports from the US Census Bureau and the US International Trade Commission. Unloaded using import and export price data obtained from the US Bureau of Labor Statistics. Following the model of imperfect substitutes, imports are assumed to depend on the real exchange rate and GDP in the United States and exports on the real exchange rate and GDP in the rest of the world. Data on the CPI devalued real effective exchange rate are obtained from the Bank for International Settlements and data on US GDP from the Organization for Economic Co-operation and Development. Data on GDP in the rest of the world is calculated as a geometrically weighted average of GDP in 15 leading trading partners, with GDP data again coming from the Organization for Economic Co-operation and Development. The model was estimated using DOLS and data from 1994Q1 to 2019Q4. Four lags and two different first right-hand variables, quarterly dummies, time trend, and global financial crisis explanatory elements were also included in the model.

The resulting import function is:

Sample period = 1995Q2-2019Q4, adjusted R squared = 0.991, corrected standard errors in parentheses, *** denotes significance at the 1% level.

In equation (1) IM represents real US imports excluding oil, RER represents real effective exchange rate, and USGDP represents real US GDP. The results suggest that a 10% appreciation of the dollar would increase imports by 5.0% and that a 10% increase in US GDP would increase imports by 21.0%.

The corresponding results for exports are:

Sample period = 1995Q2-2019Q4, adjusted R squared = 0.991, corrected standard errors in parentheses, *** denotes significance at the 1% level.

In equation (2) EX represents real exports of the United States, RER represents the real effective exchange rate, and ROWGDP represents real GDP in the rest of the world. The results indicate that a 10 percent appreciation of the dollar would reduce exports by 5.2 percent and a 10 percent increase in the rest of global GDP would increase exports by 31.7 percent.


The Marshall-Lerner condition states that, starting with equilibrium trade, a depreciation of a currency will improve a country’s balance of trade if the sum of the absolute values ​​of the export-import elasticities exceeds one. The price elasticity of equations (1) and (2) satisfies this condition. This indicates that the depreciation of the dollar would help improve the trade balance

Between 2000 and 2021, the US current account deficit averaged 3.4% of US GDP. So far the rest of the world has been willing to fund this deficit in the United States. If the rest of the world grows unwilling to continue accumulating US assets on this scale, the value of the dollar will fall. The above results indicate that consumption will help in improving the trade balance. However, the price flexibility is not great. This means that consumption alone will not be enough to rebalance trade. This would force some adjustment to come through a decline in US GDP. Such an adjustment would be painful for US workers, consumers, and businesses.

The US budget deficit has averaged 6.6% of GDP over the past 12 years. This fiscal stimulus increases the GDP of the United States and thus increases the current account deficit of the United States. The US budget deficit that caused the panic in 1985 was less than 5% of GDP. So the US budget and current account deficits that led to urgent action in the Plaza Accord are now being run over year after year. To help reduce the current account deficit and to help fight inflation, the United States must reduce its budget deficit.

This post was written by Willem Thorbeck.

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