December 1, 2002
Juann H. Hung and Charles Bronowski
This paper derives and estimates a current account model from the perspective that the current account balance is the difference between national savings and investment. This approach allows us to include determinants of savings, investment, and capital flows to explain and forecast the evolution of the current account, an advantage not offered by the elasticity approach, which views the current account balance as the sum of net exports and net investment income. The savings-investment approach shows that the three traditional variables the real exchange rate, domestic activities, and foreign activities do exert a significant influence on the current account, as postulated by the elasticity approach. More important, it shows that some variables overlooked by the elasticity approach namely, the share of dependents in the foreign population, real U.S. and foreign interest rates, and U.S. corporate profits also matter for the current-account adjustment, while the government budget balance does not. The finding that the budget balance is not a significant determinant of the current account suggests that U.S. private savings may have tended to adjust to offset changes in the government budget. Overall, models based on the savings-investment approach track and forecast the U.S. current account much better than models based on the elasticity approach.