TY - JOUR AU - Ferrero, Andrea AU - Gertler, Mark AU - Svensson, Lars E.O. TI - Current Account Dynamics and Monetary Policy JF - National Bureau of Economic Research Working Paper Series VL - No. 13906 PY - 2008 Y2 - April 2008 DO - 10.3386/w13906 UR - http://www.nber.org/papers/w13906 L1 - http://www.nber.org/papers/w13906.pdf N1 - Author contact info: Andrea Ferrero University of Oxford Office 241 Manor Road Building Manor Road Oxford OX1 3UQ United Kingdom Tel: +44 (0) 1865 281485 Fax: +44 (0) 1865 271094 E-Mail: andrea.ferrero@economics.ox.ac.uk Mark Gertler Department of Economics New York University 269 Mercer Street, 7th Floor New York, NY 10003 Tel: 212/998-8931 Fax: 212/995-4186 E-Mail: mark.gertler@nyu.edu Lars E.O. Svensson Department of Economics Stockholm School of Economics P.O. Box 6501 SE-11383 Stockholm Sweden E-Mail: Leosven@gmail.com M1 - published as Andrea Ferrero, Mark Gertler, Lars E. O. Svensson. "Current Account Dynamics and Monetary Policy," in Jordi Galí and Mark J. Gertler, editors, "International Dimensions of Monetary Policy " University of Chicago Press (2009) M3 - presented at "International Dimensions of Monetary Policy Conf.", June 11-13, 2007 AB - We explore the implications of current account adjustment for monetary policy within a simple two-country DSGE model. Our framework nests Obstfeld and Rogoff's (2005) static model of exchange rate responsiveness to current account reversals. It extends this approach by endogenizing the dynamic adjustment path and by incorporating production and nominal price rigidities in order to study the role of monetary policy. We consider two different adjustment scenarios. The first is a "slow burn" where the adjustment of the current account deficit of the home country is smooth and slow. The second is a "fast burn" where, owing to a sudden shift in expectations of relative growth rates, there is a rapid reversal of the home country's current account. We examine several different monetary policy regimes under each of these scenarios. Our principal finding is that the behavior of the domestic variables (for instance, output, inflation) is quite sensitive to the monetary regime, while the behavior of the international variables (for instance, the current account and the real exchange rate) is less so. Among different policy rules, domestic inflation targeting achieves the best stabilization outcome of aggregate variables. This result is robust to the presence of imperfect pass-through on import prices, although in this case stabilization of consumer price inflation performs similarly well. ER -