||Jordan, Alwyn; Stanford, Sunielle (2006)
How can monetary authorities or policy makers determine whether the current account balance is problematic? One approach is based on the intertemporal consumption-smoothing model. From a theoretical viewpoint, the economy should be able to rely on the current account (through capital flows) to smooth out aggregate consumption in the event of shocks to national cash flow. This approach refers to the intertemporal consumption-smoothing model (or simply consumption-smoothing) and incorporates the permanent income theory of consumption. But does this theoretical perspective apply in reality? This paper utilises the intertemporal consumption-smoothing model – which is used to derive the optimal current account - to answer these questions. The optimal current-account model is applied to Barbados, Jamaica and Trinidad & Tobago. Once this model has been derived, it is then compared with actual current account balances and more stringent statistical tests to indicate the efficacy of the model. The important finding in this study is while the optimal consumption-smoothing model is not applicable to Barbados, in contrast, the optimal model that assumes no restrictions on capital flows is valid for Jamaica and Trinidad & Tobago.