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Current account and exchange rate dynamics


  • Lilia Cavallari


In the theoretical part of the paper, we analyze the positive and normative effects of a surprise monetary expansion in a small open economy characterized by imperfect competition and short-run price rigidity in the domestic sector. The temporary output boom fostered by the monetary expansion is shown to come at the cost of a permanent squeeze of the domestic sector. In general this affects welfare ambigously, since the welfare gain from the monetary expansion reduces as net foreign assets become smaller and eventually turns negative if the economy accumulates too large a debt towards the rest of the world. The empirical part of the paper provides evidence in favour of a crucial role of monetary shocks in current account fluctuations. This holds especially for the more open economies in the G7, namely the European countries and Canada.

Suggested Citation

  • Lilia Cavallari, 1999. "Current account and exchange rate dynamics," Working Papers 38, University of Rome La Sapienza, Department of Public Economics.
  • Handle: RePEc:sap:wpaper:wp38

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    References listed on IDEAS

    1. Svensson, Lars E O & van Wijnbergen, Sweder, 1989. "Excess Capacity, Monopolistic Competition, and International Transmission of Monetary Disturbances," Economic Journal, Royal Economic Society, vol. 99(397), pages 785-805, September.
    2. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, January.
    3. Laurence Ball & David Romer, 1990. "Real Rigidities and the Non-Neutrality of Money," Review of Economic Studies, Oxford University Press, vol. 57(2), pages 183-203.
    4. Kollman, R., 1996. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: a Quantitative Investigation," Cahiers de recherche 9614, Universite de Montreal, Departement de sciences economiques.
    5. Jaewoo Lee & Menzie D. Chinn, 1998. "The Current Account and the Real Exchange Rate: A Structural VAR Analysis of Major Currencies," NBER Working Papers 6495, National Bureau of Economic Research, Inc.
    6. Richard Clarida & Jordi Gali, 1994. "Sources of real exchange rate fluctuations: how important are nominal shocks?," Proceedings, Federal Reserve Bank of Dallas, issue Apr.
    7. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May.
    8. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-660, June.
    9. Elliott, Graham & Fatas, Antonio, 1996. "International business cycles and the dynamics of the current account," European Economic Review, Elsevier, vol. 40(2), pages 361-387, February.
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    Cited by:

    1. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, vol. 54(2), pages 235-266, August.
    2. Massimo Giuliodori, "undated". "The Empirical Relevance of a basic sticky-price intertemporal model," Working Papers 2001_17, Business School - Economics, University of Glasgow.
    3. Darius, Reginald, 2010. "The macroeconomic effects of monetary and fiscal policy in a small open economy: Does the exchange rate regime matter?," Journal of International Money and Finance, Elsevier, vol. 29(8), pages 1508-1528, December.
    4. Thomas Lubik, 2003. "Industrial Structure and Monetary Policy in a Small Open Economy," Economics Working Paper Archive 493, The Johns Hopkins University,Department of Economics.

    More about this item


    small open economy; current account; monetary transmission mechanism; structural VAR.;

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance


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