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A new perspective on "the new rule"of the current account

  • Tille, Cedric
  • van Wincoop, Eric

In an influential series of contributions, Kraay and Ventura (2000, 2003) offer a "new rule" for the current account: in response to a temporary income shock, the change in the current account is equal to the change in saving times the ratio of net foreign assets to wealth. We analyze the impact of a temporary income shock on the current account in the context of a two-country dynamic general equilibrium model of portfolio choice and show that the new rule does not hold. We also show that the cross-section evidence reported by Kraay and Ventura in favor of the new rule is a feature implied by the steady state of the model that is conceptually distinct from the new rule. We argue that the new rule could only hold in a model with one-way capital flows (only inflows or outflows, but not both), a feature that is strongly counterfactual.

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

Volume (Year): 80 (2010)
Issue (Month): 1 (January)
Pages: 89-99

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Handle: RePEc:eee:inecon:v:80:y:2010:i:1:p:89-99
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  1. Devereux, Michael B & Sutherland, Alan, 2006. "Solving for Country Portfolios in Open Economy Macro Models," CEPR Discussion Papers 5966, C.E.P.R. Discussion Papers.
  2. Kraay, Aart & Ventura, Jaume, 1997. "Current accounts in debtor and creditor countries," Policy Research Working Paper Series 1825, The World Bank.
  3. Eric Van Wincoop & Cedric Tille, 2007. "International Capital Flows," NBER Working Papers 12856, National Bureau of Economic Research, Inc.
  4. 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.
  5. Fidora, Michael & Fratzscher, Marcel & Thimann, Christian, 2006. "Home bias in global bond and equity markets: the role of real exchange rate volatility," Working Paper Series 0685, European Central Bank.
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