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The current account and the new rule in a two-country world

  • Inaki Erauskin-Iurrita

    (University of Deusto San Sebastian)

This paper studies the impact of transitory income shocks (fluctuations in output, for example) on the current account in a two-country world. According to the standard intertemporal approach (or “the traditional rule”) to the current account, the variation in the current account is equal to the amount of saving generated by a transitory income shock in all countries. In contrast, Kraay and Ventura (2000, p. 1137) brilliantly argue that “the current account response is equal to the saving generated by the shock multiplied by the country’s share of foreign assets in total assets”, which they have termed “the new rule”. Here we propose an extension of the new rule to a two-country world. Then we study the empirical relevance of the extended new rule in contrast to either the traditional rule or the new rule. We find that the extended new rule adds important insights, even though the empirical validation is not completely satisfactory.

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File URL: http://128.118.178.162/eps/if/papers/0412/0412004.pdf
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Paper provided by EconWPA in its series International Finance with number 0412004.

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Length: 40 pages
Date of creation: 09 Dec 2004
Date of revision:
Handle: RePEc:wpa:wuwpif:0412004
Note: Type of Document - pdf; pages: 40
Contact details of provider: Web page: http://128.118.178.162

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  1. Kraay, Aart & Loayza, Norman & Serven, Luis & Ventura, Jaume, 2004. "Country Portfolios," Policy Research Working Paper Series 3320, The World Bank.
  2. Jacob Frenkel & Assaf Razin, 1996. "Fiscal Policies and Growth in the World Economy," MIT Press Books, The MIT Press, edition 3, volume 1, number 0262561042, June.
  3. Barry Eichengreen, 1990. "Trends and Cycles in Foreign Lending," NBER Working Papers 3411, National Bureau of Economic Research, Inc.
  4. Davide Fiaschi, 1996. "Fiscal policies and growth," Working Papers 261, Dipartimento Scienze Economiche, Universita' di Bologna.
  5. Philip Lane & Gian Maria Milesi-Ferretti, 2001. "THE EXTERNAL WEALTH OF NATIONS: Measures of Foreign Assets and Liabilities For Industrial and Developing Countries," Trinity Economics Papers 20014, Trinity College Dublin, Department of Economics.
  6. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-29, June.
  7. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, volume 1, number 5474, March.
  8. Kraay, Aart & Ventura, Jaume, 2002. "Current Accounts in the Long and Short Run," CEPR Discussion Papers 3440, C.E.P.R. Discussion Papers.
  9. Kraay, A. & Ventura, J., 1997. "Current Acounts in Debtor and Creditor Countries," Working papers 97-12, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Olivier Blanchard & Francesco Giavazzi, 2002. "Current Account Deficits in the Euro Area: The End of the Feldstein Horioka Puzzle?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 147-210.
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