The behaviour of the real exchange rate and current account

This paper investigates the joint dynamic response of the current account and the real exchange rate to permanent and temporary shocks using structural VAR models for seven developed and five developing countries. Due to the ambiguity of the unit roots test, model specification based on both stationary and non-stationary current accounts are employed. Capital flows are also included to capture external shocks as well as potential structural breaks due to financial liberalization. We find that the differences between the results when the current account is modelled as stationary and non-stationary are non-trivial. Changes inthe current account are mainly driven by temporary shocks such as monetary shocks or disturbances while real exchange rate fluctuations are dominated by permanent shocks.