Monetary Policy and the Current Account: Theory and Evidence

72 Pages Posted: 18 Apr 2016

See all articles by Ida Hjortsoe

Ida Hjortsoe

Bank of England

Martin R. Weale

National Institute of Economic and Social Research (NIESR)

Tomasz Wieladek

Bank of England

Date Written: March 2016

Abstract

Does the current account improve or deteriorate following a monetary policy expansion? We examine this issue theoretically and empirically. We show that a standard open economy DSGE model predicts that the current account response to a monetary policy shock depends on the degree of economic regulation in different markets. In particular, financial (product market) liberalisation makes it more likely that the current account deteriorates (improves) following a monetary expansion. We test these theoretical predictions with a varying coefficient Bayesian panel VAR model, where the coefficients are allowed to vary as a function of the degree of financial, product and labour market regulation on data from 1976Q1-2006Q4 for 19 OECD countries. Our empirical results support the theory. We therefore conclude that following a monetary policy expansion, the current account is more likely to go into deficit (surplus) in countries with more liberalised financial (product) markets.

Keywords: Balance of Payments; Current Account; Bayesian Panel VAR; Economic Liberalisation; Monetary Policy. JEL classification: F32, E52

JEL Classification: C11, C23, E52, F32

Suggested Citation

Hjortsoe, Ida Maria and Weale, Martin R. and Wieladek, Tomasz, Monetary Policy and the Current Account: Theory and Evidence (March 2016). CEPR Discussion Paper No. DP11204, Available at SSRN: https://ssrn.com/abstract=2766532

Ida Maria Hjortsoe (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Martin R. Weale

National Institute of Economic and Social Research (NIESR) ( email )

2 Dean Trench Street
Smith Square
London SW1P 3HE
United Kingdom

HOME PAGE: http://www.niesr.ac.uk/

Tomasz Wieladek

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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