Present-value Model Of Current Account Research Articles

IS AN INTERTEMPORAL MODEL OF THE CURRENT ACCOUNT VALID FOR EAST ASIAN COUNTRIES? EVIDENCE FROM STRUCTURAL VAR

This paper aims to examine the validity of present-value model of current account (PVMCA) by analyzing dynamic responses of variables in PVMCA to structural shocks. In place of the cross-equation restriction tests used in existing research, we adopted a structural vector autoregression framework and obtain three findings. First, evidences from 4 East Asian countries supported the intertemporal theoretical expectation that country-specific transitory shocks significantly affect current accounts, whereas the effects of global and country-specific permanent shocks are negligible. Second, country-specific transitory shocks that primarily affected current account variance dominate net output variation. Third, global permanent and transitory shocks mainly affecting variances in world interest rates and exchange rates secondarily explain current account variance. Therefore, three explanatory variables of PVMCA sufficiently explain current account variations. In practice, investors can use the PVMCA to forecast changes in current accounts; they further judge business risks stemming from the changes, and adjust their security portfolio.

The Current Account Dynamics in Pakistan: An Intertemporal Optimisation Perspective.

The intertemporal approach has become a basic reference in open economy macroeconomics for the theoretical understanding of the current account. Since the early 1980s there has been substantial growth in the literature using this approach to analyse the behaviour of the current account movements for different countries and time periods. The theoretical refinements in the approach have led most of the empirical studies in the literature today to apply the basic present value model of current account (PVMCA) and its extended version to examine the fluctuations in the current account balances of both developed and developing countries. Using data on Pakistan over the period 1960 to 2009, the present study finds that the basic model fails to predict the dynamics of the actual current account. However, extending the basic model to capture variations in the world real interest rate and the real exchange rate significantly improves the fit of the intertemporal model. The extended model predictions better replicate the volatility of current account data and better explain historical episodes of current account imbalance in Pakistan. JEL classification: C32, F32, F41 Keywords: Current Account, Present Value Models, Consumption-based Interest Rate, Pakistan