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

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Author Info

  • 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.

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File URL: http://128.118.178.162/eps/if/papers/0412/0412004.pdf
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Bibliographic Info

Paper provided by EconWPA in its series International Finance with number 0412004.

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Length: 40 pages
Date of creation: 09 Dec 2004
Date of revision:
Handle: RePEc:wpa:wuwpif:0412004

Note: Type of Document - pdf; pages: 40
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Web page: http://128.118.178.162

Related research

Keywords: intertemporal approach; current account; traditional rule; new rule;

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  1. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
  2. Aart Kraay & Norman Loayza & Luis Serven & Jaume Ventura, 2000. "Country Portfolios," NBER Working Papers 7795, National Bureau of Economic Research, Inc.
  3. Kraay, Aart & Ventura, Jaume, 1997. "Current accounts in debtor and creditor countries," Policy Research Working Paper Series 1825, The World Bank.
  4. 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.
  5. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 1999. "The External Wealth of Nations: Measures of Foreign Assets and Liabilities for Industrial and Developing Countries," CEPR Discussion Papers 2231, C.E.P.R. Discussion Papers.
  6. Eichengreen, Barry, 1990. "Trends and Cycles in Foreign Lending," CEPR Discussion Papers 451, C.E.P.R. Discussion Papers.
  7. Frenkel, Jacob & razin, assaf & Yuen, chi-wa, 1996. "Fiscal policies and growth in the world economy," MPRA Paper 22109, University Library of Munich, Germany.
  8. Aart Kraay & Jaume Ventura, 2002. "Current Accounts in the Long and Short Run," NBER Working Papers 9030, National Bureau of Economic Research, Inc.
  9. Davide Fiaschi, 1996. "Fiscal policies and growth," Working Papers 261, Dipartimento Scienze Economiche, Universita' di Bologna.
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