Current Account Imbalance and Exchange Rate Policy

The sharp rise in the price of crude oil during the latter half of 1990 resulting from the Middle East crisis brings to the fore the issue of the impact of external shocks to the economies in the Asian and Pacific region and how to respond to such shocks. The immediate impact of the Middle East crisis is on the balance-of-payments positions of the region’s economies, primarily due to the rise in oil import payments or oil export earnings and, for some countries, from a reduction in workers’ remittances. For countries which have a substantial current account imbalance even before the Middle East crisis, it exacerbated the current account imbalance and heightened the policy issues that must be tackled to address the imbalance. How much of the current account imbalance is financiable? How far should there be exchange rate change? Should there be a sharp one-shot devaluation? How tight should the fiscal and monetary regime be? How far can we sacrifice growth for stabilization? These are some of the questions that policymakers tend to ask when confronted with the problem of large current account deficits…