Determinants of cyclicality in the current account balance

Abstract

PurposeThe purpose of this paper is to study the role of public and private imbalances in the cyclicality of the current account balance in a sample of advanced and developing countries. Within developing countries, the evidence does not establish the dependency of private investment on private savings and private consumption is the main driver of the saving/investment balance. In contrast, private savings seem to be better mobilized to finance private investment and the latter is the main driver of the saving/investment balance in advanced countries. Deterioration in the current account balance in response to higher private consumption could be detrimental to growth and external stability. In contrast, an investment strategy that promotes growth is likely to attract financial flows and reduce the risk of a widening current account deficit on external stability.Design/methodology/approachThe paper studies determinants of the current account deficit. It studies current account fluctuations in the short‐run and explains these fluctuations by analyzing movements in the underlying components: public and private savings as well as investments and resulting imbalances. Of particular interest is the interaction between the government budget deficit, the private saving/investment balance, and the current account balance.FindingsUsing time‐series estimates, co‐movements indicate that fluctuations in the current account balance in many advanced countries appear to be driven by private investment that determines cyclicality in imports. In contrast, cyclicality in the current account appears to be driven by private consumption that determines fluctuations in imports in many developing countries. In general, fluctuations in the government budget deficit are mostly driven by government investment and fluctuations in the private saving/investment balance are mostly driven by fluctuations in private investment. Further, fluctuations in the current account balance appear to be mostly driven by fluctuations in the private saving/investment balance.Originality/valueThe paper explains the dynamics of the current account in relation to developments in public and private imbalances and its underlying components. It shows the effects of changes in the budget deficit and its underlying components on cyclicality in the current account. Similarly, cyclicality in the current account balance with cyclical movements in private savings and investment is studied, along with which factors affect the components of the current account balance. In particular, the paper establishes which components of the current account significantly respond to the cyclical changes in macroeconomic variables.