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Interest Rates, Exchange Rates and Present Value Models of the Current Account

In: International Macroeconomic Interdependence

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  • Paul R. Bergin
  • Steven M. Sheffrin

Abstract

The relaxation of restrictions on international capital flows over the last several decades has greatly increased international integration in asset markets. One indication of this integration is the rise in capital flows used to finance current account deficits, and the resulting accumulation of substantial financial imbalances. Whether such imbalances are a matter of concern depends on the theoretical framework one uses to explain and interpret them. The intertemporal approach to the current account, in its simplest form, focuses on the optimal saving decision of a representative household as it smooths consumption. For example, considering a small open economy experiencing a temporary fall in output, the country would be expected to smooth consumption by borrowing in world capital markets and thereby run a current account deficit. This basic intertemporal model has been extended in many directions in the theoretical literature, to include investment, variable interest rates, nontraded goods, and even monetary policy.

Suggested Citation

  • Paul R. Bergin & Steven M. Sheffrin, 2017. "Interest Rates, Exchange Rates and Present Value Models of the Current Account," World Scientific Book Chapters, in: International Macroeconomic Interdependence, chapter 10, pages 287-316, World Scientific Publishing Co. Pte. Ltd..
  • Handle: RePEc:wsi:wschap:9789813225343_0010
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    References listed on IDEAS

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    1. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476.
    2. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-185, March.
    3. Campbell, John Y., 1999. "Asset prices, consumption, and the business cycle," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 19, pages 1231-1303, Elsevier.
    4. Otto, Glenn & Voss, Graham M., 1995. "Consumption, external assets and the real interest rate," Journal of Macroeconomics, Elsevier, vol. 17(3), pages 471-494.
    5. Huang, Chao-Hsi & Lin, Kenneth S., 1993. "Deficits, government expenditures, and tax smoothing in the United States: 1929-1988," Journal of Monetary Economics, Elsevier, vol. 31(3), pages 317-339, June.
    6. Campbell, John Y, 1987. "Does Saving Anticipate Declining Labor Income? An Alternative Test of the Permanent Income Hypothesis," Econometrica, Econometric Society, vol. 55(6), pages 1249-1273, November.
    7. Milbourne, Ross & Otto, Glenn, 1992. "Consumption Smoothing and the Current Account," Australian Economic Papers, Wiley Blackwell, vol. 31(59), pages 369-384, December.
    8. Sheffrin, Steven M. & Woo, Wing Thye, 1990. "Testing an optimizing model of the current account via the consumption function," Journal of International Money and Finance, Elsevier, vol. 9(2), pages 220-233, June.
    9. Sheffrin, Steven M. & Woo, Wing Thye, 1990. "Present value tests of an intertemporal model of the current account," Journal of International Economics, Elsevier, vol. 29(3-4), pages 237-253, November.
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    More about this item

    Keywords

    Macroeconomics; International; Cooperation; Business Cycles; Exchange Rate; Current Account;

    JEL classification:

    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions

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