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I would like to thank Stanley Black, Eric Clifton, Saleh Nsouli, and the participants of an IMF Institute seminar for helpful comments and suggestions. I am grateful to Paul Bergin and Paul Cashin for providing the Gauss codes used for the empirical estimation.
The standard PVMCA has a number of underlying assumptions. First, it assumes that the home country and the trading partners produce goods that are physically identical (so there is no direct role for the terms of trade). Second, it assumes no transport costs, taking all goods to be tradable across countries (i.e., it excludes nontraded goods and as a result fails to take into consideration possible effects of changes in the real exchange rate on the current account).
This is the current account balance obtained from implementing the present-value model of the current account empirically.
This conjecture reflects Lucas’ (1976) position that policy analysis must be based on the actual forward-looking decision rules of economic agents. The microeconomic foundation of macroeconomic analysis permits the imposition of structure on the macro model.
This is the total consumption expenditure from the dynamic budget constraint in (2).
See Campbell et al (1997): 306–307, for the properties of a random variable that is conditionally lognormal distributed.
Given the condition that the empirical implementation of the model will be based on demeaned variables, the preference parameter, a constant, is dropped from equation (11).
The constant term at the end of the expression will drop out of the empirical model when we later demean the consumption based interest rate using (10).
This is necessary given the assumption of a variable interest rate. It replaces the usual discount factor
Appendix II provides the detailed derivation of (16). The same procedure is used in transforming (17) and the entire intertemporal budget constraint.
The stationarity of the optimal current account is due to the stationarity of changes in net output adjusted for the consumption based interest rate.
There are many reasons why Ricardian equivalence does not generally hold in practice, including liquidity constraints, rule of thumb consumption behavior, and the presence of distortionary taxes. As Milesi-Ferretti and Razin (1996) suggest, strong links between the current account and fiscal balances should be observed in underdeveloped financial system (i.e., where liquidity constraints are likely to be more binding). However, there is one argument that may work towards the validity of Ricardian equivalence in the context of the Nigerian economy: the public debt levels are high, and the possibility of budget deficits leading to imminent tax increases is conceivable, thereby enhancing the link between public and private sector savings behavior.
Data availability during the period covered by this study influenced the choice of the three countries.
Real exchange rates are used as proxies for the relative prices of nontradables in terms of either tradables or exportables. The fact that the relative prices of nontradables expressed in terms of either tradables or exportables may not necessarily move with real exchange rates in reality is recognized. See, for example, Kakkar and Ogaki (1999) for a detailed discussion on the relationship between the relative price of nontradables and exchange rates.
In the current context,