Smooth transition, non-linearity and current account sustainability: Evidence from the European countries

Abstract

In this paper we examine three types of nonlinearities, i.e., nonlinearity stemming from structural breaks, sign nonlinearity and size nonlinearity, for ten European countries and their importance to current account sustainability. For this purpose, we apply a battery of linear and nonlinear unit root tests. Our results show that the structural break nonlinearity and size nonlinearity are vital to the current account-GDP ratios of European countries in testing for the null hypothesis of a unit root. Nevertheless, the current account-GDP ratios of these countries do not exhibit the sign nonlinearity. That is, by taking account of the nonlinear trend, the threshold autoregressive and momentum threshold autoregressive models do not detect any asymmetry in the response of the current account imbalance to deviations from its long-run nonlinear trend.