DP3545 Towards a Theory of Current Accounts

Author(s): Jaume Ventura
Publication Date: September 2002
Keyword(s): current account theory, short and long term capital flows
JEL(s): F21, F32
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3545

The current accounts data of industrial countries exhibits some strong patterns that are inconsistent with the intertemporal approach to the current account. This is the basic model that international economists have been using for more than two decades to think about current account issues. This paper shows that it is possible to go a long way towards reconciling the theory and the data by introducing two additional features to the basic model: investment risk and adjustment costs to investment. Moreover, these extensions generate new and unexpected theoretical predictions that receive substantial support in the data. The overall message is therefore positive: with a couple of reasonable modifications, the intertemporal approach to the current account provides a fairly good description of the industrial country data.