DP3153 External Wealth, the Trade Balance and the Real Exchange Rate

Author(s): Philip R. Lane, Gian Maria Milesi-Ferretti
Publication Date: January 2002
Keyword(s): net foreign assets, real exchange rate, trade balance
JEL(s): F21, F31, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3153

We examine the link between the net foreign asset position, the trade balance and the real exchange rate. In particular, we decompose the impact of a country?s net foreign asset position (?external wealth?) on its long-run real exchange rate into two mechanisms: the relation between external wealth and the trade balance; and, holding fixed other determinants, a negative relation between the trade balance and the real exchange rate. We also provide additional evidence that the relative price of nontradables is an important channel linking the trade balance and the real exchange rate.