DP7325 The process by which the Dollar will fall: the effect of forward-looking consumers

Author(s): Karlygash Kuralbayeva , David Vines

Publication Date: June 2009

Keyword(s): imperfect substitutability , Net foreign assets , valuation effects

JEL(s): F32 , F41 , G15

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP7325.asp.asp

This paper extends the analysis of the forthcoming fall in the dollar by Blanchard, Giavazzi and Są 2005), using a model which incorporates forward-looking consumers. It provides additional underpinnings for the idea of a rapid adjustment in the value of the dollar. We analyze what will happen to the dollar value when forward-looking consumers, in anticipation of the reduction in the current account deficit, cut their consumption. We show that the real interest rate must fall as a result, and that this causes the exchange rate to fall more initially. However we also show that the interest rate does not fall greatly initially, and so that these effects are not large. But they add to pressures causing a rapid fall in the dollar.