Interest rates, exchange rates and present value models of the current account

This paper develops a testable intertemporal model of the current account t hat allows for variable interest rates and exchange rates. These additional variables are channels through which external shocks may influence the dom estic current account. The restrictions from the theoretical model are subj ected to present value tests using quarterly data from three small open eco nomies. The paper finds that including the interest rate and exchange rate improves the fit of the intertemporal model over what was found in previous studies. The model predictions better replicate the volatility of current account data and better explain historical episodes of current account imba lance.