Adjusting the US Current Account Deficit: What role for

Prior to the creation of the euro in 1999, policy-makers frequently expressed their expectation that the new currency would contribute to more stability in the international monetary relations, while some academics warned that the attractiveness of the Euro as an international currency might lead to a massive overvaluation (Portes and Rey, 1998). The experience with the euro exchange rate since its inception has not validated either of these views. The nominal effective exchange rate has become more stable for Japan, unchanged for Euroland and more flexible for the US. The focus of much public debate has been on the bilateral dollar-euro rate, while the yen-euro rate has received less attention. The preoccupation with bilateral dollar rates is understandable, given the US’s dominating position in the world economy. It may also reflect, at least in part, the growing imbalances between the US and the rest of the world and the potential role of the exchange rate in the adjustment process. Avoiding a hard landing for the world economy may require reviewing forms of monetary cooperation in a tri-polar world. While the strong dollar in 2000 has attenuated the exuberance in the US economy and stimulated Euroland’s economy, its weakness had the opposite effect in recent years. At the same time Asia and, to a lesser extend, Europe supply the savings to the United States that American residents do not generate domestically. While this developmen