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Policy Brief 05-4

The Case for a New Plaza Agreement

by William R. Cline, Peterson Institute for International Economics

December 2005

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William R. ClineThe United States is running an increasing risk by allowing its external current account deficit to rise to levels historically unprecedented for the United States and most other industrial countries. This trend can be arrested through a credible program to eliminate the US fiscal deficit by 2010 combined with an accord, like the Plaza Agreement of 1985, to achieve appreciation of a wide array of foreign currencies against the dollar. A Plaza II would help achieve global adjustment in three ways: First, it would resolve the "prisoner's dilemma" for major developing and newly industrialized economies, in which each country acts in isolation to stem a loss of competitiveness, leaving the world as a whole worse off. Second, it would provide a framework for coordinated intervention—dollar sales by the European Central Bank and Bank of Japan and purchases of euros, yen, and possibly other currencies by the Federal Reserve. Third, by including a program for US fiscal adjustment, a Plaza II would assure countries allowing their currencies to rise that the United States, too, was carrying its share of the adjustment burden.