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How Well Can the New Open Economy Macroeconomics Explain the Exchange Rate and Current Account?

  • Paul R. Bergin

This paper advances the new open economy macroeconomic (NOEM) literature in an empirical direction, estimating and testing a two-country model. Fit to U.S and G-7 data, the model performs moderately well for the exchange rate and current account. Results offer guidance for future theoretical work. Parameter estimates lend support to some common assumptions in the theoretical literature, such as local currency pricing and risk sharing. Estimates are found for key parameters commonly calibrated in the theoretical literature, such as the elasticity of substitution between home and foreign composite goods, and the response of a country risk premium to the net foreign asset position. Results also indicate that deviations from interest rate parity are not closely related to monetary policy shocks, as recently hypothesized. Further, results suggest that inserting explicit interest rate parity shocks into a NOEM model may be more helpful in explaining movements in the current account than the exchange rate.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10356.

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Date of creation: Mar 2004
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Publication status: published as Bergin, Paul R., 2006. "How well can the New Open Economy Macroeconomics explain the exchange rate and current account?," Journal of International Money and Finance, Elsevier, vol. 25(5), pages 675-701, August.
Handle: RePEc:nbr:nberwo:10356
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