This paper presents an empirical analysis of the factors that contributed to the unprecedented widening of the U.S. external deficit between 1980 and 1986. The paper presents an empirical model of the
U.S. current account that is used to assess the relative importance of changes in U.S. price competitiveness and changes in U.S. and foreign growth as determinants of the deficit. We find that while both factors were significant, the decline in U.S. competitiveness associated with the appreciation of the dollar was the dominant factor. The analysis is also pursued at a more fundamental level, using the results of various multicountry model simulations. We find that shifts in U.S. and foreign fiscal policy could account for over half of the widening of the deficit, but only part of the rise in the dollar. Given the importance of the dollar's appreciation to the widening of the deficit, we ask, finally, why the deficit (particularly in real terms) has been so slow to respond
to the dollar's decline since early 1985. Several possible explanations are considered and we conclude that the delay can be attributed largely to normal lags in the response of trade prices and volumes to exchange rate changes. Moreover, the real net export deficit would have widened substantially further in the absence of the depreciation.
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Last update: November 24, 2008