DP1280 International Business Cycles and the Dynamics of the Current Account

Author(s): Graham Elliott, Antonio Fatás
Publication Date: November 1995
Keyword(s): Current Account, International Business
JEL(s): E32, F32, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1280

This paper analyses the transmission of productivity shocks across countries and how the responses of investment and the current account differ depending on the degree of propagation of the shocks. We explore both issues by estimating a structural model for Japan, the United States and Europe. We postulate, as an identifying assumption, that the propagation of shocks is proportional to trade. We find that there is a strong asymmetry in that shocks to the United States propagate quickly to the other two economies, while European and Japanese shocks have little impact on other countries' productivity. We find that productivity increases lead to domestic investment booms and current account deficits. Investment in other countries tends to react positively to productivity shocks, even when the shock is purely national. This second result contradicts the predictions of a standard open-economy model with perfect capital mobility where, in response to country-specific shocks, domestic and foreign investment should move in opposite directions. We also find quantitative differences among the three countries in the response of the current account. These differences are not related to the global or idiosyncratic nature of the shocks.