Semi-Parametric Predictions of the Intertemporal Approach to the Current Account

This paper uses dunamic programming by GMM (DM by GMM) to solve a dynamic model of a small-open economy calibrated to Canada. The predicted paths for consumption, output, investment and trade balance (over output) are highly correlated with thier historical counterparts. Moreover, the variance of the predicted trade balance- output ratio matches the variance observed in the data. The latter result contrasts with earier research on the intertemporal approach to the current account using linear-quadratic modeals that found that the sample paths for the current account predicted by the theory are less volatile than the historical paths in Canadian data. It is shown that a special case of the model with a constant world interest rate does not match the historical path of the trade balance as well.