Current accounts in debtor and creditor countries

The authors reexamine a classic question in international economics: What is the current account response to a transitory income shock such as a temporary improvement in the terms of trade, a transfer from abroad, or unusually high production To answer this question, they construct a world equilibrium model in which productivity varies across countries and international borrowing and lending take place to exploit good investment opportunities. Despite its conventional ingredients, the model generates the novel prediction that favorable income shocks lead to current account deficits in debtor countries and current account surpluses in creditor countries. Evidence from thirteen OECD countries broadly supports this theoretical prediction.