The current account and the new rule in a not-so-small open economy

This paper provides an extension of the new rule for the current account [Kraay and Ventura (2000)], abandoning the small open economy assumption: the response of transitory income shocks on the current account is equal to the new rule (savings generated by the shock multiplied by the domestic holdings of foreign assets over total domestic assets) plus the saving generated by the shock in the foreign economy multiplied by the foreign country’s share of domestic capital in foreign total assets. The extended new rule provides a good description for the behavior of current accounts, and is even better than the new rule, which would be rejected by recent evidence.