^*Marcel Fratzscher is a division chief and Roland Straub a senior economist with the European Central Bank. The authors would like to thank the participants at the conference on "Current Account Sustainability in Major Advanced Economies" at the University of Wisconsin, Madison, and in particular our discussant, Ken West, for comments and discussion.

Abstract

The paper analyses the effect of equity-price shocks on current account positions for the G-7 industrialized countries during 1974–2007. It uses a Bayesian vector autoregression with sign restrictions for the identification of equity-price shocks and to test empirically for their effect on current accounts. Such shocks are found to exert a sizable effect, with a 10 percent equity price increase, for example, in the United States relative to the rest of the world, worsening the U.S. trade balance by 0.9 percentage points after 16 quarters. However, the response of the trade balance to equity-price shocks varies substantially across countries. The evidence suggests that the channels accounting for this heterogeneity function both through wealth effects on private consumption and to some extent through the real exchange rate of countries.