The Current Account And The Intertemporal Budget Constraint: Evidence From G-7 Countries

Abstract

A random coefficients, error-correction model of saving-investment behaviour, which is consistent with intertemporal open-economy models, is estimated for G-7 countries to infer about the current account, capital mobility and the relevance of intertemporal budget constraints in such model. The error-correction mechanism is especially suited here since it is able to integrate short run dynamics with long run behaviour, while the random coefficients approach is a natural specification for accommodating inter-country differences. If saving-investment correlations measure capital mobility, a positive correlation would mean that a country’s growth prospects would be constrained by its saving, government deficits would crowd out private investment and, at a broader level, good investment opportunities might have to be foregone unless the required resources were obtained through a sacrifice in current consumption. On the other hand, those correlations could also be seen as validating the use of intertemporal budget constraints in open-economy models.