One purpose of floating exchange rates is to help global imbalances resolve themselves (at a basic level if you are running a trade surplus then your currencies should rally (purchasing power becomes greater, other regions become more competitive, and hopefully at some point the surplus (savers) country will spend their funds…so that they debtor country doesn’t explode)). But currencies have a large number of other influences on them (the most significant of which is capital flows), so does it work just this way. We’ll here’s a chart that tries to tell when currencies are doing the job of resolving global imbalances (when the blue line is positive it is ‘working’).
The charts shows the 12 mth moving average of the slope of an OLS (regression…read ‘a line drawn through points’) on the real exchange rate against the current account balance. If you are running a surplus then your currency ’should’ go up (this would mean that a positive slope suggest that the currency markets are working’). The blue line is the sum of countries current accounts as a % of local GDP…this is supposed to get a the size of global imbalances. So what you’d like to see it the red line (the imbalances line) close(r) to zero but to the extent that it is not one would hope that the blue line would become go higher.
Admittedly this is way too complicated for what it is trying to do and it has problems in that it is dealing with a change (in the currency) and a level, sort of, in the current account balance. The results are some what sensitive to the period that is chosen for the currency change. (if you are interested I’ve chosen 24 month changes). All that said I still think it is an interesting picture….why?
Because it shows that global imbalances blew up after 97/98 when the currencies stopped ‘working’, getting more in balance as currencies ‘worked’ between 00-03, and then expanding again when currencies stopped working again. (Although given that the world has significant non-floating currencies, its not fair to blame it all on ‘non-economic’ markets)…
