current strongaccountstrong and real exchange rate dynamics in the g7.pdfVIP

Journal of International Money and Finance 25 (2006) 257e274 /locate/econbase Current account and real exchange rate dynamics in the G7 countries Jaewoo Lee a,*, Menzie D. Chinn b,c a IMF, Research Department, 700 19th Street, NW, Washington, DC 20431, USA b Robert M. La Follette School and Economics Department, University of Wisconsin, 1180 Observatory Drive, Madison, WI 53706, USA c NBER, Cambridge, MA 02138, USA Abstract The canonical predictions of intertemporal open-economy macro models are tested by a structural VAR analysis of G7 countries. The analysis is distinguished from the previous literature in that it adopts min- imal assumptions for identification. Consistent with a large set of theoretical models, permanent shocks have large long-term effects on the real exchange rate, but relatively small effects on the current account; temporary shocks have large effects on the current account and exchange rate in the short run, but not on either variable in the long run. The signs of some impulse responses point toward models that differentiate tradables and nontradables. 2005 Elsevier Ltd. All rights reserved. JEL classification: F31; F41 Keywords: Real exchange rate; Current account; Intertemporal models 1. Introduction The modeling of real exchange rate and of the current account determination has been, and remains, one of the most enduring and challenging topics of research in open-economy macroeco- nomics. However, until quite recently, the study of the two variables has proceeded on largely separate tracks. For instance, the typical examination of the real exchange rate relies upon either interest rate and purchasing power parity conditions