||“Save for a rainy day”, a well known theory proposed in Campbell(1987), indicates that the current consumption depends on the rational prospect of future economy. Nevertheless, within a highly developed economy, individual’s consumption is often affected by various factors, for instance, the rate of time preference, interest rates and inflation, …etc. Therefore, a rational representative consumer should take all possible information available to them into consideration in making decisions regarding optimal consumption; meanwhile, this will in turn affects a country’s current accounts and domestic credit as well.|
Based on the viewpoints of consumption-smoothing and permanent income hypothesis, we modify Ghosh(1995a)’s methodology to incorporate one of the most important macroeconomic variables, “money” into the intertemporal approach to the current account to explore its influence in explaining the difference between theoretically predicted and actual current accounts.
In this study, four major industrialized countries: Canada, Japan, the US and UK are investigated by adding money as one of the key elements in explaining their current accounts dynamics. According to the empirical findings, not only the national cash flow (output minus investment and government expenditure) as stated in the literatures but money stock also reflect their influential effects in determinating the dynamic behavior of current accounts also. Therefore, money dose play a crucial role in our extensive method in explaining what traditional method can not explain.
Further, we used six kinds of test which are introduced by Diebold and Mariano（1995）to compare which estimation model has better explaining power to forecast the actual current account.
As a whole, the current accounts of these four major industrialized countries indeed acts as a buffer to smooth consumption in facing fluctuations of shocks to national cash flow and money stock.