Dynamics of the Current Account and Interest Differentials

In contrast to earlier work, we study the relation between the current account and interest rate differentials. To do so, we document the relation for international data. We then interpret this relation from a two-country, dynamic, general equilibrium environment. We finally confront the relation predicted by the environment to the relation observed in the data. We find that the environment correctly predicts that the current account is countercyclical; that the interest differential is procyclical; and that the current account is negatively correlated with current and future interest differentials, but positively correlated with past interest differentials.