Patterns of Current Account Adjustment—Insights from Past Experience

Abstract

Theoretical models on trade balance adjustment make a distinction between adjustment led by relative quantities (expenditure reduction) and adjustment led by relative prices (expenditure switching). Using cluster analysis on a set of over 70 current account adjustment episodes, we confirm the empirical relevance of this theoretical distinction, as quantity and price-driven adjustment cases can be distinguished in a statistically meaningful sense. We also identify a group of mixed cases, where both quantities and prices played a significant role in adjustment. Multinomial logit results suggest that economic fundamentals and business cycle positions prior to the adjustment have predictive power over the type of adjustment, i.e. whether the adjustment is quantity– or price-driven. The exchange rate regime and the level of economic development (emerging market versus advanced status) do not have significant predictive power.