The Intrinsic Relationship Between the U.S. Dollar Current Account Deficit and the U.S. Dollar Index

Abstract

Maintaining balance in the balance of payments, as one of the major objectives of macroeconomic regulation, not only helps a country's economy achieve a balance between exchange rate stability and economic growth amid domestic and international interactions but also plays an important role in promoting high-quality macroeconomic development. To this end, this study analyzes the relationship between the current account balance and the real effective exchange rate using relevant data for the United States, the United Kingdom, France, Germany, and Japan from 1960 to 2025 obtained from the World Bank's World Development Indicators (WDI) database. The empirical results yield three main findings. First, overall, a higher current account balance as a share of GDP is associated with an appreciation of the domestic currency, thereby enhancing its competitiveness. Second, for the United States, the relationship between the current account balance and the real effective exchange rate is not statistically significant. One possible explanation is that capital account inflows, in addition to the current account deficit, contribute to the relative strength of the U.S. dollar. This finding to some extent reflects the dollar's status as the world's major reserve currency. Third, in the sample of the United Kingdom, France, Germany, and Japan, excluding the United States, the current account balance continues to have a significant positive effect on the exchange rate, while faster economic growth also contributes to domestic currency appreciation. Based on these cross-country heterogeneous empirical results, this study proposes policy recommendations in three areas: Optimise the structure of imports and exports, coordinate cross-border capital regulations, and build a monitoring and early warning system for the balance of payments and exchange rates. Based on the above results, it can be seen that high-income countries need to adjust their domestic and foreign policies simultaneously to reduce exchange-rate fluctuations.