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Current accounts, net foreign assets and the implications of cyclical factors

  • Matthieu Bussiere
  • Georgios Chortareas
  • Rebecca L Driver

Intertemporal models of the current account suggest that temporary income shocks are fully reflected in a country's net foreign asset position, so that agents invest abroad any savings generated by a positive income shock. On the other hand, a stylised fact in international economics is that there is a disproportionately large share of domestic assets in investors' portfolios. If investment risk is high and diminishing returns are weak, then savings from temporary income shocks may, in fact, be invested according to the existing portfolio composition. This implies that any bias in portfolios persists after a temporary shock. A model is estimated that explicitly allows for the possibility that the impact of initial portfolio allocation, proxied using net foreign assets, may differ, depending on whether shocks are permanent or temporary. The results, from a panel of 18 OECD countries, suggest that initial portfolio allocation affects current account behaviour following temporary, but not permanent, shocks. These results are therefore compatible with the 'new rule'.

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Paper provided by Bank of England in its series Bank of England working papers with number 173.

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Date of creation: Jan 2003
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Handle: RePEc:boe:boeewp:173
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