Macroeconomics Case Study

Trade Deficits, Current Account Deficits and Exchange Rates in US: The Policy Implications

OR

Abstract:
By 1950s, the US became an economic superpower – exacting trade relations with almost all countries and posted huge trade surplus with all trading partners. This soon gave US dollar universal acceptance and elevated it to the status of world’s single largest reserve currency. However, in the wake of globalisation and the emergence of low-cost manufacturers, US trade surplus took a dent and eventually turned into deficit. The introduction of euro – single currency for 15 European nations – in 2002, challenged the dollar as the reserve currency backed by EU’s trade with rest of the world. Since then, dollar has been weakening – even further after theUSwaged two costlywars, swelling its current account deficits.Aggravated by widespread uncertainty over the US economy, caused by subprime mortgage crisis, the dollar seemed to lose its long-held status as a strong reserve currency. With remote chances of improvement in the country’s balances, dollar’s recovery is far off. This case study helps analyse whether it is possible for the governments or the central banks to control all factors responsible for exchange rate fluctuations.

Pedagogical Objectives:

• To understand various types of deficit
• To analyse the factors responsible for exchange rate fluctuation
• To understand how far current account deficit leads to the exchange rate fluctuations.

Keywords : US Dollar, Current Account Deficit, Currency Pegging, Trade Deficit, Marshall Plan, Dollar Depreciation, Capital Inflows, Budget Deficit, Carter Bonds, Recession, Reserve Currency, Monetary Policy