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A New Perspective on "The New Rule"of the Current Account

  • Eric van Wincoop

    (University of Virginia and NBER)

  • Cedric Tille

    (Graduate Institute Geneva)

In an influential contribution that predates the recent renewed interest in portfolio choice models of international capital flows, Kraay and Ventura (2000) o¤er a "new rule" for the current account that puts portfolio choice at the center of the analysis. The new rule says that in response to a change in saving, the change in the current account is equal to the change in saving times the ratio of net foreign asset to wealth. We show that while the focus on portfolio choice is well placed, the inferences in terms of the international allocation of savings are misleading. Using a simple two-country general equilibrium model with portfolio choice, we show that the "new rule" does not hold; most of an increase in a country's saving will be invested abroad. We also show that the empirical evidence presented in Kraay and Ventura (2000) in favor of the "new rule" is consistent with an expression for the current account that holds in the steady state of almost any model. The "new rule" does not necessarily follow as an implication.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 452.

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Date of creation: 2008
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Handle: RePEc:red:sed008:452
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  1. Aart Kraay & Jaume Ventura, 2000. "Current Accounts In Debtor And Creditor Countries," The Quarterly Journal of Economics, MIT Press, vol. 115(4), pages 1137-1166, November.
  2. 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.
  3. Cedric Tille & Eric van Wincoop, 2007. "International Capital Flows," Working Papers 122007, Hong Kong Institute for Monetary Research.
  4. 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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