Exchange Rate and Current Account Dynamics Under Rational Expectations: An Econometric Analysis

An econometric portfolio balance model of an open economy, incorporating exchange rate, price, and current account dynamics, is derived and estimated.The usual stability conditions do not guarantee a unique rational expectations solution, and several proposals for resolving this situation are considered. Using constrained maximum likelihood methods, the model is estimated for Japan.The estimation results indicate that the model is quite successful in explaining the patterns found in the data. The model is estimated using several methods of resolving the question of non-uniqueness, and the results are compared.