DP4920 | Current Account Theory and the Dynamics of US Net Foreign Liabilities

Publication Date

23/02/2005

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Abstract

This paper provides empirical evidence on the adjustment dynamics of the US net foreign liabilities, net output and consumption. We use empirical techniques that allow us to quantify the relative importance of permanent and transitory innovations. We find that transitory shocks contribute considerably to the variation in all three variables for a horizon up to a year, and their contribution remains significant for a horizon up to five years. A permanent shock ? that we interpret as a technological shock ? dominates the variation of all variables at longer horizons. In response to this shock, net foreign liabilities, net output and consumption all increase ? consistent with the effect of productivity gains raising domestic return to capital and thus generating an inflow of foreign capital. Conversely, shocks that cause net output and consumption to increase temporarily are accompanied by short-run accumulation of net foreign assets ? in contrast with traditional model predicting procyclical current account deficits in response to temporary output fluctuations. Instead, our results are qualitatively consistent with predictions of the intertemporal approach to the current account.