Exchange-rate effects on China's trade: an interim report

The rising current account deficit in the USA has attracted considerable attention in recent years. We use the "business cycle accounting" methodology to identify the principal distortions that have affected the external accounts of the US. In particular, we measure distortions in the optimality conditions of a simple two-country general equilibrium model using data from the US and the other G7 countries. We then feed these measured distortions into the model individually and use the simulated counterfactual paths of the current account to determine the contribution of each of these "wedges" to the overall external imbalance of the USA. We find that no single wedge in isolation can account closely for the observed current account. However, a combination of productivity differences and deviations from risk-sharing between the US and the rest of the G7 does the best job in accounting for most of the measured movement of the US current account.