The U.S.

Current Account Deficit

Harvard Business School Case 706-002

Courseware 706-701
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ASSUMPTIONS AND FACTS

theta
mu
alpha
beta
delta
gamma
notes:

1
2
0.7
0.8
0.7
0.25

Change assumptions (yellow fields)

Modify baseline facts (white fields)
Hit Ctrl+r for results
Fill in results table (end of workbook)
substitution elasticity between tradable and nontradable goods
substition elasticity between imported and domestically produced tradable goods (if mu=100, all tradable goods perfect substitutes)
US and European weight on home products in tradable goods basket
(beta-alpha)=US and European weight on each others' tradables; [1-alpha-(beta-alpha)]=US and European weight on Asian tradables
Asian weight on home products in tradable goods basket
share of traded goods in total consumption

1>beta>alpha>0.5; delta>0.5; (increasing theta and mu simulates a more gradual unwinding: 2&4 for 5-7 years, 4&8 for 10-12 years).

US production nontradables/GDP
US production tradables/GDP
EUR production nontradables/GDP
EUR production tradables/GDP
Asia production nontradables/GDP
Asia production tradables/GDP
US current account/tradable US GD
EUR current account/tradable US G
Asia current account/tradable US G
US gross foreign assets ($tns)
US gross foreign liab ($tns)
EUR gross foreign assets ($tns)
EUR gross foreign liab ($tns)
Asia gross foreign ass ($tns)
Asia gross foreign liab ($tns)
interest rate on US liabilities
interest rate on non-US liabilities

start
0.75
0.25
0.75
0.25
0.75
0.25
-0.2
0.05
0.15
8.25
11.00
11.00
11.00
11.00
8.25

new

0
0
0
10.02
11.14
13.60
13.94
11.74
10.27

3.75% 3.75%
5.00%

US share of external liab in dollars

US shr ext liab in EUR currencies
US shr ext liab in Asian currencies
US share of ext assets in dollars
US shr ext ass in EUR currencies
US shr ext ass Asian currencies
EUR share of external liab in dolla
EUR shr ext liab in EUR currencies
EUR shr ext liab in Asian currencie
EUR share external assets in dollar
EUR shr ext ass in EUR currencies
EUR shr ext ass Asian currencies
Asia share of external liab in dolla
Asia shr ext liab in EUR currencies
Asia shr ext liab in Asian currencie
Asia share of external assets dollar
Asia shr ext ass EUR currencies
Asia shr ext ass Asian currencies

96.4%
3.0%
0.6%
40.2%
40.5%
19.3%
20.0%
80.0%
0.0%
31.8%
57.4%
10.9%
34.0%
33.0%
33.0%
80.0%
20.0%
0.0%

US tradable GDP ($tns)

Asia shr ass inv in US (not $ specific)
EUR shr ass inv in US (not $ specific)
US shr short-term liab in total liab

2.75
0.6
0.4
0.3

Calculations needed for model:

US prod tradables/EUR prod tradables and
US prod tradables/Asian prod tradables
sigma U/E
1.00
sigma U/A
1.00
net income payments as % US tradable GDP
step 1
step 2
step 3
r*f U
0.00%
0.00%
3.03%
r*f E
-2.00%
-2.00% -3.10%
r*f A
2.00%
2.00% -0.54%

Source: Model developed based on equations presented in Maurice Obstfeld and Kenneth Rogoff, Global Current Account Imbalances and Exchange Rate Adjustments, prepared for
spring 2005 meeting of the Brookings Panel on Economic Activity, draft dated May 16, 2005.

fect substitutes)

sian tradables

STEP 1
t U,E
t U,A
xU
xE
xA
Equ 1
Equ 2
Equ 3
Equ 4
Equ 5
q U, E
q U, A

0.8384784416
0.9530879282
1.2351409121
0.8798026727
0.8754027174
1.00
1.00
3.00
3.00
3.00
0.6971
0.7476

terms of trade US versus Europe

terms of trade US versus Asia
US prices nontraddables/prices tradables
Europe prices nontradables/price tradedables
Asia prices nontradables/price tradables
1.00
0.000
1.00
sigma N/U
3.00 US production nontradables/production tradables
sigma N/E
3.00 Eur production nontradables/production tradables
sigma N/A
3.00 Asia production nontradables/production tradables
real exchange rate dollar versus European currencies
real exchange rate dollar versus Asian currencies

STEP 2
t U,E
t U,A
xU
xE
xA
Equ 1
Equ 2
Equ 3
Equ 4
Equ 5
q U, E
q U, A

0.9878796582
1.1275499086
0.9789044575
0.9541684232
1.0588698068
1.00
1.00
3.00
3.00
3.00
0.9737
1.1250

terms of trade US versus Europe

terms of trade US versus Asia
US prices nontraddables/prices tradables
Europe prices nontradables/price tradedables
Asia prices nontradables/price tradables
1.00
0.000
1.00
sigma N/U
3.00 US production nontradables/production tradables
sigma N/E
3.00 Eur production nontradables/production tradables
sigma N/A
3.00 Asia production nontradables/production tradables
real exchange rate dollar versus European currencies
real exchange rate dollar versus Asian currencies

STEP 3
t U,E
t U,A
xU
xE
xA
Equ 1
Equ 2
Equ 3
Equ 4
Equ 5
q U, E
q U, A

0.9628699673
1.1018244989
1.0152186037
0.9399723448
1.0376306031
1.00
1.00
3.00
3.00
3.00
0.9222
1.0643

terms of trade US versus Europe

terms of trade US versus Asia
US prices nontraddables/prices tradables
Europe prices nontradables/price tradedable step 1
Asia prices nontradables/price tradables
1.00
(0.000)
1.00
sigma N/U
3.00 US production nontradables/production tradables
sigma N/E
3.00 Eur production nontradables/production tradables
sigma N/A
3.00 Asia production nontradables/production tradables
real exchange rate dollar versus European currencies
real exchange rate dollar versus Asian currencies

OUTPUT
step 1
q u,e
0.6971
q u,a
0.7476
q e,a 1.07245338
t u, e 0.83847844
t u, a 0.95308793
t e, a 1.13668746

step 2

0.9737
1.1250
1.1554061728
0.9878796582
1.1275499086
1.1413838712

step 3
change
change (including reval)
0.9222
33.4%
28.0% real depreciation of $ against european currencies
1.0643
40.9%
35.3% real depreciation of the $ against asian currencies
7.5% 1.154099
7.3% real depreciation of the european against asian currencies
0.96287
16.4%
13.8% real depreciation of terms of trade in US versus Europe
16.8% 1.1018245
14.5% real depreciation of terms of trade in US versus Asia
0.4% 1.1443129
0.7% real depreciation of terms of trade in Europe versus Asia

Source: Model developed based on equations presented in Maurice Obstfeld and Kenneth Rogoff, Global Current Account Imbalances and
Exchange Rate Adjustments, prepared for spring 2005 meeting of the Brookings Panel on Economic Activity, draft dated May 16, 2005.

Location in O&R paper

see page 59
see page 60
see page 60
see page 60
see page 60
see page 55
see page 55

ation of $ against european currencies

ation of the $ against asian currencies

ation of the european against asian currencies

ation of terms of trade in US versus Europe

ation of terms of trade in US versus Asia

ation of terms of trade in Europe versus Asia

, Global Current Account Imbalances and

mic Activity, draft dated May 16, 2005.

OUTPUT (based on assumptions and facts below)

log change log change
excluding including
(changes are against two-year average reference rates)
revaluationrevaluation
effects
effects
q u,e
33.4% 28.0% real depreciation of dollar against European currencies
q u,a
40.9% 35.3% real depreciation of dollar against Asian currencies
q e,a
real depreciation of European against Asian currencies
7.5%
7.3%
t u,e
16.4% 13.8% terms of trade US versus European countries
t u,a
16.8% 14.5% terms of trade US versus Asian countries
t e,a
terms of trade European versus Asian countries
0.4%
0.7%
ASSUMPTIONS AND FACTS
1 substitution elasticity between tradable and nontradable goods
theta
2 substition elasticity between imported and domestically produced tradable goods (if mu=100, all tradable goods perfect substitutes)
mu
0.7 US and European weight on home products in tradable goods basket
alpha
0.8 (beta-alpha)=US and European weight on each others' tradables; [1-alpha-(beta-alpha)]=US and European weight on Asian tradables
beta
0.7 Asian weight on home products in tradable goods basket
delta
0.25 share of traded goods in total consumption
gamma
notes:

1>beta>alpha>0.5; delta>0.5; (increasing theta and mu simulates a more gradual unwinding: 2&4 for 5-7 years, longer for 4&8).

US production nontradables/GDP
US production tradables/GDP
EUR production nontradables/GDP
EUR production tradables/GDP
Asia production nontradables/GDP
Asia production tradables/GDP
US current account/tradable US GDP
EUR current account/tradable US G
Asia current account/tradable US G
US gross foreign assets ($tns)
US gross foreign liab ($tns)
EUR gross foreign assets ($tns)
EUR gross foreign liab ($tns)
Asia gross foreign ass ($tns)
Asia gross foreign liab ($tns)
interest rate on US liabilities
interest rate on non-US liabilities

start
0.75
0.25
0.75
0.25
0.75
0.25
-0.2
0.05
0.15
8.25
11.00
11.00
11.00
11.00
8.25

3.75%
5.00%

new

0
0
0
10.02
11.14
13.60
13.94
11.74
10.27
3.75%

US share of external liab in dollars

US shr ext liab in EUR currencies
US shr ext liab in Asian currencies
US share of ext assets in dollars
US shr ext ass in EUR currencies
US shr ext ass Asian currencies
EUR share of external liab in dollar
EUR shr ext liab in EUR currencies
EUR shr ext liab in Asian currencie
EUR share external assets in dollar
EUR shr ext ass in EUR currencies
EUR shr ext ass Asian currencies
Asia share of external liab in dollar
Asia shr ext liab in EUR currencies
Asia shr ext liab in Asian currencie
Asia share of external assets dollar
Asia shr ext ass EUR currencies
Asia shr ext ass Asian currencies

96.4%
3.0%
0.6%
40.2%
40.5%
19.3%
20.0%
80.0%
0.0%
31.8%
57.4%
10.9%
34.0%
33.0%
33.0%
80.0%
20.0%
0.0%

US tradable GDP ($tns)

Asia shr ass inv in US (not $ specific)
EUR shr ass inv in US (not $ specific
US shr short-term liab in total liab

2.75
0.6
0.4
0.3

Calculations needed for model:

US prod tradables/EUR prod tradables and
US prod tradables/Asian prod tradables
sigma U/E
1.00
sigma U/A
1.00
net income payments as % US tradable GDP
step 1
step 2
step 3
r*f U
0.00%
0.00% 3.03%
r*f E
-2.00%
-2.00% -3.10%
r*f A
2.00%
2.00% -0.54%

Source: Model developed based on equations presented in Maurice Obstfeld and Kenneth Rogoff, Global Current Account Imbalances and Exchange Rate Adjustments, prepared for spring
2005 meeting of the Brookings Panel on Economic Activity, draft dated May 16, 2005.

RESULTS TABLE
real depreciation of real depreciation of real depreciation of
dollar against
dollar against Asian European against
European
currencies
Asian currencies
currencies
1. Initial baseline facts, all current account balances
go to zero, no change in interest rates, no revaluation
effects
2. Initial baseline facts, all current account balances
go to zero, no change in interest rates, including
revaluation effects
3. Initial baseline facts, all current account balances
go to zero, U.S. interest rates increase to 5%,
including revaluation effects
4. Slow adjustment theta set to 2, mu to 4, current
accounts to 0, with revaluation effects
5. Conservative test same as 2., but theta set to 2
instead of 1
6. Testing elimination of terms of trade same as 2.,
but mu set to 100 instead of 2
7. Milder global rebalancing same as 2., but
current account balances halve rather than fall to 0
8. Symmetric country preferences same as 2., but
beta set to .85

change in terms of
trade US versus
European countries

change in terms of
trade US versus
Asian countries

change in terms of
trade European
versus Asian
countries