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The current account and the new rule in a two-country world

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  • Inaki Erauskin-Iurrita

    (University of Deusto San Sebastian)

Abstract

This paper studies the impact of transitory income shocks (fluctuations in output, for example) on the current account in a two-country world. According to the standard intertemporal approach (or “the traditional rule”) to the current account, the variation in the current account is equal to the amount of saving generated by a transitory income shock in all countries. In contrast, Kraay and Ventura (2000, p. 1137) brilliantly argue that “the current account response is equal to the saving generated by the shock multiplied by the country’s share of foreign assets in total assets”, which they have termed “the new rule”. Here we propose an extension of the new rule to a two-country world. Then we study the empirical relevance of the extended new rule in contrast to either the traditional rule or the new rule. We find that the extended new rule adds important insights, even though the empirical validation is not completely satisfactory.

Suggested Citation

  • Inaki Erauskin-Iurrita, 2004. "The current account and the new rule in a two-country world," International Finance 0412004, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpif:0412004
    Note: Type of Document - pdf; pages: 40
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    References listed on IDEAS

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    1. Aart Kraay & Jaume Ventura, 2003. "Current Accounts in the Long and the Short Run," NBER Chapters, in: NBER Macroeconomics Annual 2002, Volume 17, pages 65-112, National Bureau of Economic Research, Inc.
    2. Aart Kraay & Norman Loayza & Luis Servén & Jaume Ventura, 2005. "Country Portfolios," Journal of the European Economic Association, MIT Press, vol. 3(4), pages 914-945, June.
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    4. Aart Kraay & Jaume Ventura, 2000. "Current Accounts in Debtor and Creditor Countries," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 115(4), pages 1137-1166.
    5. Jacob Frenkel & Assaf Razin, 1996. "Fiscal Policies and Growth in the World Economy," MIT Press Books, The MIT Press, edition 3, volume 1, number 0262561042, April.
    6. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-329, June.
    7. Eichengreen, Barry, 1990. "Trends and Cycles in Foreign Lending," CEPR Discussion Papers 451, C.E.P.R. Discussion Papers.
    8. Olivier Blanchard & Francesco Giavazzi, 2002. "Current Account Deficits in the Euro Area: The End of the Feldstein Horioka Puzzle?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 147-210.
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    More about this item

    Keywords

    intertemporal approach; current account; traditional rule; new rule;
    All these keywords.

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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