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Title: Monetary Policy and the Current Account: Theory and Evidence

Author(s): Ida Hjortsoe, Martin Weale and Tomasz Wieladek

Publication Date: March 2016

Keyword(s): Balance of Payments, Bayesian Panel VAR, current account, E52, Economic Liberalisation and Monetary Policy. JEL classification: F32

Programme Area(s): International Macroeconomics and Finance and Monetary Economics and Fluctuations

Abstract: Does the current account improve or deteriorate following a monetary policy expansion? We examine this issue theoretically and empirically. We show that a standard open economy DSGE model predicts that the current account response to a monetary policy shock depends on the degree of economic regulation in different markets. In particular, financial (product market) liberalisation makes it more likely that the current account deteriorates (improves) following a monetary expansion. We test these theoretical predictions with a varying coefficient Bayesian panel VAR model, where the coefficients are allowed to vary as a function of the degree of financial, product and labour market regulation on data from 1976Q1-2006Q4 for 19 OECD countries. Our empirical results support the theory. We therefore conclude that following a monetary policy expansion, the current account is more likely to go into deficit (surplus) in countries with more liberalised financial (product) markets.

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Bibliographic Reference

Hjortsoe, I, Weale, M and Wieladek, T. 2016. 'Monetary Policy and the Current Account: Theory and Evidence'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11204