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Habit formation and the present-value model of the current account: Yet another suspect

  • Kano, Takashi

In a recent paper, Gruber (Gruber, J.W., 2004. A present value test of habits and the current account. Journal of Monetary Economics 51, 1495-1507) claims that habit formation in consumption plays an important role in current account fluctuations in selected developed countries, extending the present-value model of the current account (PVM) with consumption habits. In this paper, however, I show that the habit-forming PVM is observationally equivalent to the PVM augmented with persistent transitory consumption, which is induced by world real interest rate shocks. Based on a small open-economy real business cycle (SOE-RBC) model endowed with consumption habits as well as persistent world real interest rate shocks, this paper resolves the inherent identification problem of the habit-forming PVM by Bayesian methods to seek effects of habit formation on current account fluctuations in typical small open economies, Canada and the United Kingdom. Results reveal no clear evidence that habit formation plays a crucial role in current account fluctuations.

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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 78 (2009)
Issue (Month): 1 (June)
Pages: 72-85

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Handle: RePEc:eee:inecon:v:78:y:2009:i:1:p:72-85
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505552

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  1. James M. Nason and John H. Rogers, 2001. "The Present Value Model of the Current Account Has Been Rejected: Round Up the Usual Subjects," Computing in Economics and Finance 2001 102, Society for Computational Economics.
  2. Sheffrin, S.M. & Woo, W.T., 1989. "Present Value Tests Of An Intertemporal Model Of The Current Account," Papers 61, California Davis - Institute of Governmental Affairs.
  3. Otrok, C. & Ravikumar, B. & Whiteman, C., 1998. "Habit Formation: A Resolution of the Equity Premium Puzzle?," Working Papers 98-04, University of Iowa, Department of Economics.
  4. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
  5. Reuven Glick & Kenneth Rogoff, 1993. "Global Versus Country-Specific Productivity Shocks and the Current Acocount," Boston University - Institute for Economic Development 31, Boston University, Institute for Economic Development.
  6. Frank Schorfheide, 2000. "Loss function-based evaluation of DSGE models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(6), pages 645-670.
  7. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
  8. Takashi Kano & Hafedh Bouakez, 2005. "Learning-by-Doing or Habit Formation?," 2005 Meeting Papers 513, Society for Economic Dynamics.
  9. Gruber, Joseph W., 2004. "A present value test of habits and the current account," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1495-1507, October.
  10. Chang, Yongsung & Gomes, Joao F & Schorfheide, Frank, 2002. "Learning by Doing as a Propagation Mechanism," CEPR Discussion Papers 3599, C.E.P.R. Discussion Papers.
  11. G. Constantinides, 1990. "Habit formation: a resolution of the equity premium puzzle," Levine's Working Paper Archive 1397, David K. Levine.
  12. Davidson, Russell & MacKinnon, James G., 1993. "Estimation and Inference in Econometrics," OUP Catalogue, Oxford University Press, number 9780195060119, March.
  13. Schmitt-Grohe, Stephanie & Uribe, Martin, 2003. "Closing small open economy models," Journal of International Economics, Elsevier, vol. 61(1), pages 163-185, October.
  14. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
  15. William Blankenau & M. Ayhan Kose & Kei-Mu Yi, 1999. "Can world real interest rates explain business cycles in a small open economy?," Staff Reports 94, Federal Reserve Bank of New York.
  16. Steven M. Sheffrin & Paul Bergin, 2003. "Interest Rates, Exchange Rates And Present Value Models Of The Current Account," Working Papers 9722, University of California, Davis, Department of Economics.
  17. Ghosh, Atish R, 1995. "International Capital Mobility amongst the Major Industrialised Countries: Too Little or Too Much?," Economic Journal, Royal Economic Society, vol. 105(428), pages 107-28, January.
  18. Bussière, Matthieu & Fratzscher, Marcel & Müller, Gernot J., 2004. "Current accounts dynamics in OECD and EU acceding countries - an intertemporal approach," Working Paper Series 0311, European Central Bank.
  19. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
  20. Nason, James M & Rogers, John H, 2002. "Investment and the Current Account in the Short Run and the Long Run," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(4), pages 967-86, November.
  21. Bouakez, Hafedh & Kano, Takashi, 2008. "Terms of trade and current account fluctuations: The Harberger-Laursen-Metzler effect revisited," Journal of Macroeconomics, Elsevier, vol. 30(1), pages 260-281, March.
  22. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "The intertemporal approach to the current account," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 34, pages 1731-1799 Elsevier.
  23. John Geweke, 1998. "Using simulation methods for Bayesian econometric models: inference, development, and communication," Staff Report 249, Federal Reserve Bank of Minneapolis.
  24. Takashi Kano, 2003. "A Structural VAR Approach to the Intertemporal Model of the Current Account," Working Papers 03-42, Bank of Canada.
  25. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
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  29. repec:fth:harver:1435 is not listed on IDEAS
  30. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : II. New directions," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 309-341.
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