Essays on the current account, terms of trade, and real exchange rate dynamics

My dissertation is a theoretical and empirical investigation of the role of monetary shocks and real shocks on the current account, terms of trade, and real exchange rate dynamics. In the first essay, three new open economy macroeconomics models are studied. Model solutions are found to be different depending on the assumptions made about the household preference specification and the degree of market segmentation. The first model is a generalized two-country, two-sector model. Utility is modeled as a constant-rate-of-risk-aversion form in the aggregate consumption and real money balance; the aggregate consumption is taken to be a constant-elasticity-of-substitution index over the traded and the nontraded goods consumption. This generalized model produces the theoretical ambiguity concerning the direction of the current account, the terms of trade, and the real exchange rate movements. The second model adds the nontraded goods sector to Obstfeld and Rogoff's (1995) Redux model. The simplified preference structure generates the tractable model solutions. The third model is a pricing-to-market model with only traded goods. The pricing-to-market feature enables the model to replicate the deviations from the purchasing power parity. This model finds that in the short run, a money increase generally depreciates the domestic currency and leads to a current account surplus. The direction of the terms of trade movement responding to a money increase depends crucially on the degree of market segmentation. The empirical investigation is thus of much interest since a theory alone fails to give a clear prediction.; In the second essay, I have developed a structural vector auto-regression (SVAR) model to evaluate the empirical implications of the three new open economy macroeconomics models studied in the first essay. The empirical investigation also sheds light on the evaluation of the overall approach to the new open economy macroeconomics literature. The Blanchard-Quah style of decomposition is applied to identify a trivariate SVAR model with the current account, the terms of trade, and the real exchange rate. Three long-run identification restrictions are derived directly from the underlying intertemporal model. The impulse response functions generated by the SVAR model support the new open economy macroeconomics model with the simplified household preference specification and the model with the degree of market segmentation between zero and a half. The forecast error variance decomposition results illustrate that monetary shocks account for a substantial fraction of the terms of trade fluctuations and are also quantitatively important for the real exchange rate movements. There is no evidence showing that monetary shocks play any significant role in the current account fluctuations except in Japan, Germany, and the US.