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Should We Trust the Empirical Evidence from Present Value Models of the Current Account?

Author

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  • Mercereau, Benoît
  • Miniane, Jacques Alain

Abstract

The present value model of the current account has been very popular, as it provides an optimal benchmark to which actual current account series have often been compared. We show why persistence in observed current account data makes the estimated optimal series very sensitive to small-sample estimation error, making it close to impossible to determine whether the paths of the two series truly bear any relation to each other. Moreover, the standard Wald test of the model will falsely accept or reject the model with substantial probability. Monte Carlo simulations and estimations using annual and quarterly data from five OECD countries strongly support our predictions. In particular, we conclude that two important consensus results in the literature – that the optimal series is highly correlated with the actual series, but substantially less volatile – are not statistically robust.

Suggested Citation

  • Mercereau, Benoît & Miniane, Jacques Alain, 2008. "Should We Trust the Empirical Evidence from Present Value Models of the Current Account?," Economics Discussion Papers 2008-10, Kiel Institute for the World Economy (IfW).
  • Handle: RePEc:zbw:ifwedp:7211
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    References listed on IDEAS

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    1. Jonathan David Ostry, 1997. "Current Account Imbalances in AsEAN Countries; Are they a Problem?," IMF Working Papers 97/51, International Monetary Fund.
    2. Geert Bekaert, 2001. "Expectations Hypotheses Tests," Journal of Finance, American Finance Association, vol. 56(4), pages 1357-1394, August.
    3. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "The intertemporal approach to the current account," Handbook of International Economics,in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 34, pages 1731-1799 Elsevier.
    4. Campbell, John Y. & Shiller, Robert J., 1989. "The dividend ratio model and small sample bias : A Monte Carlo study," Economics Letters, Elsevier, vol. 29(4), pages 325-331.
    5. Nason, James M. & Rogers, John H., 2006. "The present-value model of the current account has been rejected: Round up the usual suspects," Journal of International Economics, Elsevier, vol. 68(1), pages 159-187, January.
    6. Ahmed, Shaghil, 1986. "Temporary and permanent government spending in an open economy: Some evidence for the United Kingdom," Journal of Monetary Economics, Elsevier, vol. 17(2), pages 197-224, March.
    7. Cashin, Paul & McDermott, C John, 1998. "Are Australia's Current Account Deficits Excessive?," The Economic Record, The Economic Society of Australia, vol. 74(227), pages 346-361, December.
    8. Campbell, John Y & Shiller, Robert J, 1987. "Cointegration and Tests of Present Value Models," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1062-1088, October.
    9. Gruber, Joseph W., 2004. "A present value test of habits and the current account," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1495-1507, October.
    10. Lutz Kilian, 1998. "Small-Sample Confidence Intervals For Impulse Response Functions," The Review of Economics and Statistics, MIT Press, vol. 80(2), pages 218-230, May.
    11. Sheffrin, Steven M. & Woo, Wing Thye, 1990. "Present value tests of an intertemporal model of the current account," Journal of International Economics, Elsevier, vol. 29(3-4), pages 237-253, November.
    12. Timothy Callen & Paul Cashin, 2001. "Capital controls, capital flows and external crises: evidence from India," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 11(1), pages 77-98.
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    Cited by:

    1. Elif C. Arbatli, 2008. "Futures Markets, Oil Prices and the Intertemporal Approach to the Current Account," Staff Working Papers 08-48, Bank of Canada.
    2. Oscar Bajo-Rubio & Vicente Esteve, 2017. "Optimality of the current account of the Spanish economy, 1850-2015," Working Papers 1710, Department of Applied Economics II, Universidad de Valencia.

    More about this item

    Keywords

    Current account; present value model; model evaluation;

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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