An Assessment of the Disorderly Adjustment Hypothesis for Industrial Economies


  • *We would like to thank Caroline Freund, Joe Gagnon, Edward Gramlich, Luca Guerrieri, William Helkie, David Howard, Karen Johnson, Nathan Sheets, and participants in the International Finance Division workshop, as well as Benn Steil and two anonymous referees, for helpful comments. The views expressed in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System.

Hilary Croke, Steven B. Kamin and Sylvain Leduc
Federal Reserve Board
Division of International Finance
20th St. and Constitution Avenue NW
Washington, DC 20551, USA


Much has been written about prospects for US current account adjustment, including the possibility of what is sometimes referred to as a ‘disorderly correction’: a sharp fall in the exchange rate that boosts interest rates, depresses stock prices and weakens economic activity. This paper assesses some of the empirical evidence bearing on the plausibility of the disorderly adjustment scenario, drawing on the experience of previous current account adjustments in industrial economies. We examined the paths of key economic performance indicators before, during and after the onset of adjustment, building on the analysis of Freund (2000).

We found little evidence among past adjustment episodes of the features highlighted by the disorderly adjustment hypothesis. Although some episodes in our sample experienced significant shortfalls in GDP growth after the onset of adjustment, these shortfalls were not associated with significant and sustained depreciations of real exchange rates, increases in real interest rates or declines in real stock prices. By contrast, it was among the episodes where GDP growth picked up during adjustment that the most substantial depreciations of real exchange rates occurred. These findings do not preclude the possibility that future current account adjustments could be disruptive, but they weaken the historical basis for predicting such an outcome.