An Intertemporal Benchmark Model for Turkey’s Current Account

where y_t = q_t + rb_t

If output rises relative to its permanent value, then there is a current account surplus implying
that the country is lending. If output falls below its permanent value, there is a deficit reflecting
borrowing. This is consumption smoothing behavior.

Ghosh (1995) argues that the focus on the consumption-smoothing current account⁶ is valid
for two reasons. Firstly, it is simpler to model borrowing or lending behavior for consumption
smoothing rather than consumption tilting. Also, consumption smoothing is a stationary series
which implies that standard econometric techniques may be used.

Combining equations (4) and (5) we get the optimal consumption smoothing current account

^ca* = ^-∑ (1 +r)j [^Et ^Ht+j^- it+j^- gt+j )]                                              (6)

where ∆ is the backward difference operator such that ∆x_t = x_t - x_t-1 .

From equation (6) the optimal consumption smoothing current account is related to the
present discounted value of the expected changes in the national cash flow. The focus here is on
transitory shocks, because a permanent shock to national cash flow has no impact as the expected
change is zero.

Econometric methodology

Our focus is on consumption smoothing current account. This means we need to eliminate
the consumption tilting component from the current account. Consumption tilting as discussed
earlier is given by the parameter θ which is related to the rate of interest and the discount rate.
In addition, the optimal consumption smoothing current account requires the estimation of the
present value of the expected changes in the national cash flow. Practically, the computation of
the optimal consumption smoothing current account however does not require such an estimation

⁶ As opposed to the current account which includes consumption tilting

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