External Wealth, the Trade Balance, and the Real Exchange Rate

IMF Working Papers, March 1, 2002

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External Wealth, the Trade Balance, and the Real Exchange Rate

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Bibliographic details

• Authors: Philip R. Lane, Gian M Milesi-Ferretti
• Published: March 1, 2002
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451847123.001

Core summary

• This paper examines the link between the net foreign asset position ("external wealth"), the trade balance, and the long-run real exchange rate.
• The analysis decomposes the impact of a country's net foreign asset position on its long-run real exchange rate into two mechanisms:
  • the relation between external wealth and the trade balance; and
  • holding other determinants fixed, the relation between the trade balance and the real exchange rate.
• The paper provides additional evidence that the relative price of nontradables is an important channel linking the trade balance and the real exchange rate.

Main findings and empirical focus

• Decomposition result:
  • External wealth affects the long-run real exchange rate through its effect on the trade balance.
  • Conditional on other determinants, the trade balance influences the real exchange rate.
• Channel identification:
  • The relative price of nontradables is identified as an important channel linking the trade balance to the real exchange rate.
• Subject areas and keywords emphasized in the study:
  • Foreign assets
  • Foreign currency exposure
  • Real exchange rates
  • Terms of trade
  • Trade balance
  • asset position, debtor country, output growth rate, trade balance coefficient, WP

Content in this bundle

• External Wealth, the Trade Balance, and the Real Exchange Rate - WP/02/51
  • External Wealth, the Trade Balance, and the Real Exchange Rate - WP/02/51 (Markdown version)
  • External Wealth, the Trade Balance, and the Real Exchange Rate - WP/02/51 (PDF)