Saving, Investment and Current Account Dynamics*

A standard model of a small open economy involving optimizing households and firms is used to derive the dynamics of private saving and investment. The paper is critical of a common test of perfect capital mobility, since domestic saving and investment can easily correlate positively despite the assumption of perfect capital mobility. The time path for the current account deficit is studied both analytically and through simulations. Adjustment is very slow, and overshooting in the current account is possible. Even though the government budget is balanced the current account deficit can remain large for many years before being eliminated.