The Current Account in the Macroeconomic Adjustment Process

This paper builds a formal, continuous-time model of the current account with intertemporally optimizing households to make two linked points. First, a country’s current account depends as much on anticipated future economic conditions as on today’s conditions – the same current shock to fiscal policy, foreign demand, or productivity has different current-account effects depending on whether it is expected to be temporary or permanent. Second, because of this forward-looking behavior, purely temporary disturbances leave permanent traces: by changing how much the country borrows or lends today, a temporary shock permanently alters the economy’s stock of net foreign assets and hence its long-run relative prices and output mix. The model is explicitly classical (continuous market clearing, full employment) and assumes an infinite-lived representative household facing a fixed world interest rate, so Ricardian equivalence holds and only the path of government spending – not of taxes or deficits – matters for absorption. Within this framework the paper decomposes the current account into a time-preference term (positive when the world interest rate exceeds the household’s discount rate) and consumption-smoothing terms (surpluses when foreign demand, productivity, or government spending are temporarily above their “permanent” levels), and uses this decomposition to work out how temporary, permanent, and pre-announced future shocks to fiscal policy propagate into current and future current accounts and relative prices.

Jeffrey D. Sachs | Macro Paper Warehouse

The Current Account in the Macroeconomic Adjustment Process