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

Iñaki Erauskin ()

International Finance from University Library of Munich, Germany

Abstract: 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.

Keywords: intertemporal approach; current account; traditional rule; new rule (search for similar items in EconPapers)
JEL-codes: F41 F43 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2004-12-09
Note: Type of Document - pdf; pages: 40
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