Interest rates, exchange rates and international adjustment: BW II dynamics

Recent attempts to explain the dynamics of adjustment of dollar exchange rates in the face of an anticipated deterioration of the US net international investment position have focused on portfolio balance models of exchange rate determination. In this paper we argue that such models are useful in understanding the behavior of dollar exchange rates with emerging market currencies but, consistent with a large body of empirical research, are not useful in understanding changes in the dollars value against the euro or the currencies of other developed countries. We conclude that portfolio preferences of governments of emerging markets provide the most plausible explanation for the persistent US current account deficit.