CURRENT ACCOUNT DYNAMICS AND THE REAL EXCHANGE RATE: DISENTANGLING THE EVIDENCE
Banque de France
Bank of Greece and University of East Anglia
Miguel A. León-Ledesma
University of Kent
We study the main shocks driving current account fluctuations for the G6 economies. Our theoretical framework features a standard two-goods inter-temporal model, which is specifically designed to uncover the role of permanent and temporary output shocks and the relation between the real exchange rate and the current account. We build a SVAR model including the world real interest rate, net output, the real exchange rate, and the current account and identify four structural shocks. Our results suggest four main conclusions: i) there is substantial support for the two-good intertemporal model with time-varying interest rate, since both external supply and preference shocks account for an important proportion of current account fluctuations; ii) temporary domestic shocks account for a large proportion of current account fluctuations, but the excess response of the current account is less pronounced than in previous studies; iii) our results alleviate the previous puzzle in the literature that a shock that explains little about net output changes can explain a large proportion of current account changes; iv) the nature of the shock matters to shape the relationship between the current account and the real exchange rate, which explains why is it difficult to understand the role of the real exchange rate for current account fluctuations.
JEL-classifications: F32, F41
Keywords: Current account, real exchange rate, two-good intertemporal model, SVAR
Acknowledgements: We would like to thank participants at the 3rd HenU / INFER Workshop on Applied Macroeconomics for their comments. We would also like to thank Harald Uhlig, Shaun Hargreaves-Heap and an anonymous referee for their useful suggestions. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Banque de France, Bank of Greece, or the Eurosystem.
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