The Current Account - Interest Rate Relation as a Nonlinear Phenomenon

The current account - interest rate relationship has been extensively investigated, but always assuming that it is linear. In this paper we examine the linearity versus nonlinearity issue with reference to this relationship in 11 OECD countries, and find overwhelming evidence in favour of nonlinearity. After testing alternative nonlinear specifications, we estimate a smooth transition regression model and a nonlinear VAR model. Finally, we provide a study of the innovation response analysis that shows adjustment behaviours of the two variables. The implications of the results are discussed.