Front Matter Page
Monetary and Exchange Affairs Department
Contents
Summary
I. Introduction
II. Exchange Rates and the Current Account: An Analytical Overview
A. The Canonical Mundell-Fleming Analysis
B. The Savings-Investment Gap and the Macroeconomic Balance Approach
C. The Consumption Smoothing Approach to the Current Account
D. Overlapping Generations and Life-Cycle Effects
E. Capital Flows, Uncertainty, and Sovereign Risk
F. The Monetary Approach and the Overshooting Hypothesis
III. The Current Account in Economic Policymaking
IV. Three Case Studies
A. A Group-of-Seven Country: Italy, 1992–95
B. A Small Developed Country: Israel, 1990–96
C. An External Financing-Constrained Developing Country: Pakistan, 1993–96
V. Summary and Conclusions
References
Text Tables
1. Italy: Selected Indicators, 1991–95
2. Israel: National Saving, Domestic Investment, and the Current Account, 1988–96
3. Pakistan: Selected Indicators, 1993/94–1995/96
Summary
Movements in the current account are deeply intertwined with, and convey information about, the actions and expectations of all market participants in an open economy. For this reason, policymakers focus on the current account as an important macroeconomic variable, to endeavor to explain its movements, assess its sustainable level, and seek to induce changes in the current account balance through policy actions.
This paper provides an overview of the evolution of economic thinking on the determinants of the current account, from the essentially static Mundell-Fleming paradigm developed in the 1960s to the latest intertemporal models. It then explains their implications for the behavior of the current account. Subsequently, the paper considers the relevance of these abstract theories to the real world and the practical guidance they provide to the authorities in shaping their analyses and in setting their policy stance.
The discussion then turns to three case studies, each of which elucidates aspects of current account determination and considers the different policy strategies applied. The case study of Italy during 1992–95 shows the current account impact of deviations of exchange rates from fundamentals because of fiscal and other fundamental uncertainties. That of Israel in 1990–96 reflects the impact of a major demographic shock, in this case a massive immigration flow, on the current account. Finally, the study of Pakistan in 1993–96 explores the implications of a binding external financing constraint faced by a developing country with only limited access to international financial markets.