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Testing an Intertemporal Model of the Current Account with Variable Interest Rates and Nontraded Goods: Evidence from Taiwan

Pei-Ju Liao

National Chengchi University Department of International Trade

Abstract

This paper develops four versions of the intertemporal model. The main difference among these versions is whether we include the time-varying interest rate or/and the relative price of nontraded and traded goods in the composition of the consumption-based interest rates. Empirically, we use Taiwan's quarterly and annual data to test these versions. We find that our model performs quite well if we include the relative price in our model. But the model with variable interest rates while excluding nontraded goods is strongly rejected by the data. This result shows that the relative price of nontraded and traded goods has better explaining power than time-varying interest rates. We conclude that the intratemporal effect plays a more important role than intertemporal effect in explaining Taiwan's current account.