The Current Account and the Dollar
The current account deficit narrowed in 2003:IIIQ, the first significant drop since the dollar began its recent decline. This pattern—smaller deficit, depreciating dollar—suggests that investors’ diversification out of dollar-denominated assets has become a key underlying market development. When investors diversify out of dollar assets, the supply of dollars in foreign exchange markets outpaces the demand, and the dollar depreciates. This depreciation makes U.S. goods more competitive in world markets and narrows the current account deficit. All else equal, diversification could put upward pressure on real interest rates and make investment in the U.S. harder to finance. Although it will tend to raise the prices of traded goods, a dollar depreciation fueled by investor diversification need not signal an accelerating inflation rate.
Suggested citation: "The Current Account and the Dollar," Federal Reserve Bank of Cleveland, Economic Trends, no. 04-02, pp. 09, 02.01.2004.