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Abstract:
For G-7 countries over the period 1961-1990, there appears to be a strong and stable negative correlation between annual changes in the current account and investment. Here we explore this correlation using a highly tractable empirical model that distinguishes between global and country-specific shocks. This distinction turns out to be quite important empirically, as global shocks account for roughly fifty percent of the overall variance of productivity. An apparent puzzle, however, is that the current account seems to respond by much less than investment to country-specific productivity shocks. Given the near random walk behavior of these shocks, this observation would appear to contradict a central cross-equation inequality restriction implied by the intertemporal approach. We show analytically, however, that the theoretically-predicted current account response can be extremely sensitive to small changes in the degree of mean reversion in country-specific productivity; in general, the current account response is more sensitive than is the investment response. Our results thus support the view that there is a significant convergent component to country-specific productivity shocks.
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