CURRENT ACCOUNT DYNAMICS AND THE REAL EXCHANGE RATE: DISENTANGLING THE EVIDENCE

Abstract

We study the main shocks driving current account (CA) fluctuations for the G6 economies, using a standard two-good intertemporal model. We build a structural vector autoregression model including the world real interest rate, net output (NO), the real exchange rate, and the CA and identify four structural shocks. Our results suggest four main conclusions: (i) there is substantial support for the two-good intertemporal model with time-varying interest rate, since both external supply and preference shocks account for an important proportion of CA fluctuations; (ii) temporary domestic shocks account for a large proportion of CA fluctuations, albeit smaller than in previous studies; (iii) our results alleviate the puzzle in the literature that a shock that explains little about NO changes can explain a large proportion of CA changes; (iv) the nature of the shock matters to shape the relationship between the CA and the real exchange rate.