An empirical analysis of consumption and current account in an intertemporal stochastic model

This study employs a non-linear state space model and applies Extended Kalman Filter to analyze the effects of shocks to output, investment and government consumption for the US economy within a stochastic intertemporal current account framework for the particular period 1989Q2-2019Q4. It is shown that consumption and current account dynamics are successfully explained and the real interest rate, which is needed to rationalize the consumption and income relationship, is found to be fairly reasonable. The parameter estimates of the macroeconomic variables in the model indicate high accuracy of forecast according to the MAPE criteria for model evaluation. The intertemporal substitution and compensation effects allow aggregate consumption function to absorb exogenous shocks and reflect the smooth transition of the economy to the reestablishment of equilibrium position.