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INTRODUCTION

Renewed discussion of target ranges for exchange rates and the continuing large U.S.external deficit pose the question of whether exchange rates are sustainable near current levels. This question is explored here in the context of U.S. macroeconomic adjustments.

The real exchange rate of the dollar, using a measure which includes developed and newly industrialized countries (see Figure 1), is today broadly at the level of the 1970's and of the year 1980 when the U.S. external balance showed a surplus. This position of the dollar offers a starting point for discussing whether the dollar needs to decline further. We shall conclude that this is, indeed, the case. The argument is basically that two-thirds of the present external deficit will persist even at the current level of the dollar. That leads to two further questions: if the dollar quite obviously needs to decline further, why has this not already occurred? And, what are the costs and benefits of a further dollar decline for the U.S., Europe, Japan and for debtor LDCS?

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