ABSTRACT
This chapter develops the general theoretical framework for analysing the current account balance in an intertemporal environment. The major focus of each of the theoretical analyses presented in this chapter is to show the linkage between expected future changes in the economy’s net output (gross domestic product less government and investment expenditures; all expressed in real terms) and the current account balance. Within the Present Value Model of the Current Account (hereafter PVMCA), a country’s current account position will be in deficit (surplus) whenever net output is expected to rise (fall) over time. This has the implication that in the presence of high capital mobility, the current account deficit (which, from the balance of payments identity, is identical to net capital inflows less additions to foreign exchange reserves) should serve as a buffer to smooth consumption when there are shocks to output, investment, or government expenditures (Ghosh and Ostry, 1995). This perspective on current account determination resembles Campbell’s (1987) position that, given the permanent-income hypothesis, household savings should equal the expected present value of future declines in household labour income.
