Working Papers in Economics,
University of Gothenburg, Department of Economics

Abstract: This paper extends the theory of open economy consumption behavior by applying Flavin's (1993) excess sensitivity hypothesis (ESH) to the current account. The ESH can be interpreted as a generalization of the open economy permanent income hypothesis (PIH) that allows for any degree of international capital mobility. As such, the ESH can account for why the PIH fails and for the related puzzle of an excessively volatile current account. Furthermore, the ESH suggests an alternative approach for assessing a country's degree of international capital mobility. Using annual Swedish data for the period 1951-99, the empirical evidence implies that, in contrast to the PIH, the ESH cannot be rejected.

Keywords: Excess sensitivity; Permanent income; Consumption; Current account; Capital mobility

JEL-codes: E21; F32

29 pages, February 18, 2003

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