Current Accounts in Debtor and Creditor Countries

This 2000 Quarterly Journal of Economics paper by Aart Kraay and Jaume Ventura reexamines a classic question – how does the current account respond to a transitory income shock? – and overturns the standard intertemporal prediction that such shocks always produce a current-account surplus everywhere. Building a world-equilibrium model in which international borrowing and lending arises from cross-country differences in (risky) investment opportunities rather than differences in patience, the authors show that once investment in domestic capital is modeled as risky, a favorable transitory income shock is invested in the same proportions as the country’s existing portfolio – so in debtor countries, whose wealth is more than fully committed to domestic capital, the shock is overinvested at home and produces a current-account deficit, while in creditor countries it produces the conventional surplus. This debtor/creditor split survives (with a shifted, possibly nonzero threshold) once the model allows risk aversion to vary with wealth and introduces riskless labor income, and the paper finds supporting evidence in thirteen OECD countries: current accounts are significantly countercyclical in debtor countries and procyclical in creditor countries, even after controlling for common global shocks.

Jaume Ventura | Macro Paper Warehouse

Current Accounts in Debtor and Creditor Countries