The Current Account, the Spot Exchange Rate and the Demand for Money

Abstract

We derive a theoretical balance of payments current account model from a framework that assumes a monetarymodel of exchange rates as a first state of the world, but then presumes the existence of deviations from purchasingpower parity. In such a model there is slow price adjustment where short-run exchange rates deviate from long-runequilibrium exchange rates. Under these conditions there are accumulations of net foreign assets due to currentaccount imbalances. A nonlinear model results where there is dependence between exchange rate deviations from equilibrium and the current account, as well as a concurrent dependence of the current account on exchange ratedeviations. Furthermore, the current account is also shown to depend on the demand for money. Thus the theoreticalexplanation of the current account is concomitant on the short-run exchange rate and the determinants of moneydemand. [PUBLICATION ABSTRACT]