Current Account Adjustment : Some New Theory and Evidence”, NBER Working Paper No

This paper aims to provide a theory of current account adjustment that places domestic labor market institution in the center stage. It nests the textbook version of the intertemporal approach as a special case. In general, in response to a shock, an economy adjusts through a combination of a change in the composition of goods trade (i.e., intra-temporal trade channel) and a change in the current account (i.e., intertemporal trade channel). The more rigid the labor market, the slower the speed of adjustment of the current account toward its long-run equilibrium. Three pieces of evidence are provided that are consistent with the theory