Current Account Position Research Articles

Asset Prices and Current Account Fluctuations in G7 Economies

The paper analyses the effect of equity price shocks on current account positions for the G7 industrialized countries in 1974-2007. It uses a Bayesian VAR with sign restrictions for the identification of asset price shocks and to test empirically for their effect on current accounts. Such shocks are found to exert a sizeable effect, with a 10 percent equity price increase for instance in the United States relative to the rest of the world worsening the US trade balance by 0.9 percentage points after 16 quarters. However, the response of the trade balance to equity price shocks varies substantially across countries. The evidence suggests that the channels accounting for this heterogeneity function both through wealth effects on private consumption and to some extent through the real exchange rate of countries. JEL Classification: E2, F32, F40, G1

The role of China in global external imbalances: Some further evidence

Abstract The large imbalances in the current account positions of the US and the Asian economies are seen by most scholars as the main threat to an orderly development of the global economy. While the opinions on the most likely evolution of these imbalances and on their sustainability do differ across observers, ranging from catastrophic to rather optimistic views, almost all agree that some adjustment will have to take place in the near future, and that this adjustment will involve, among other things, a rebalancing of saving and demand across the globe. As an outcome of this process, China shall increasingly supplement the US in the role of engine of global economic growth. Using a global macroeconometric model, we examine the impact on this adjustment process of a number of shocks originating in the Chinese economy, including an expansionary fiscal shock, a revaluation of the renmimbi, and an expansion of internal demand following an acceleration in the process of rural–urban migration. The analysis focuses on two related points: how will these shocks affect the medium-run evolution of transpacific imbalances, and what will their impact be on global economic growth. The simulations allow us to track the impact of these shocks on the different poles of the world economy, and to assess their relative contribution to the task of reducing global imbalances without interrupting global economic growth.

GTAP Model Analysis of the Economic Effects of an Australia–China FTA: Welfare and Sectoral Aspects

The Australia–China Free Trade Agreement (ACFTA) is already in the process of being negotiated by the two governments. This paper employs the Computable General Equilibrium (CGE) model using Global Trade Analysis Project (GTAP) database version 6 for a quantitative analysis of the economic effects of proposed ACFTA. Four scenarios are examined in the paper focusing on flexible and fixed current account positions within short run and long run. Equivalent variation (EV) and real consumption are used to measure the welfare effects resulting from the formation of the ACFTA. The results from the GTAP simulations show positive welfare effects for both Australia and China in all cases. Sectoral results show mixed outcomes.

The Impact of Oil-Related Incomeon the Equilibrium Real Exchange Rate in Syria

This paper examines the impact of oil-related income, among other fundamentals, on the equilibrium real effective exchange rate (ERER) in Syria. After reviewing the evolution of the Syrian multiple exchange rate regime since 1960 and assessing alternative measures for the exchange rate, the paper analyzes the impact of oil-related income on the ERER in the context of a behavioral equilibrium exchange rate model. The analysis concludes that ERER appreciates with higher oil-related income, productivity and net foreign assets, but, at odds with the conventional wisdom, depreciates with higher government expenditures given that an increase in expenditures usually translates into higher imports and weaker current account position. In light of the projected real shocks associated with the depletion of oil and the change in other fundamentals in the context of the ongoing transition to a market economy, a more flexible regime would serve Syria better in the future.

Equilibrium Non-Oil Current Account Assessments for Oil Producing Countries

This paper introduces a methodology for assessing external balance in countries with large stocks of non-renewable resources based on oil stock data, and applies it to selected oil producing countries. The methodology uses a stock approach (instead of the more traditional flow approach) to estimate the equilibrium non-oil current account consistent with optimal consumption smoothing. One of the benefits of the stock approach is that geological data for oil reserves can be used to estimate oil wealth; however, the methodology makes the estimated non-oil current account norm very sensitive to oil price projections. Based on an oil price about US$70 per barrel prevailing in the summer of 2007, the baseline estimates indicate that the non-oil current accounts for most of the countries in the sample are broadly in equilibrium. By the same token, using oil price projections as of the summer of 2008 implies large disparities between the equilibrium non-oil current account position and the medium term forecast for all countries in the sample except for Malaysia.

The Impact of Oil-Related Income on the Equilibrium Real Exchange Rate in Syria

This paper examines the impact of oil-related income, among other fundamentals, on the equilibrium real effective exchange rate (ERER) in Syria. After reviewing the evolution of the Syrian multiple exchange rate regime since 1960 and assessing alternative measures for the exchange rate, the paper analyzes the impact of oil-related income on the ERER in the context of a behavioral equilibrium exchange rate model. The analysis concludes that ERER appreciates with higher oil-related income, productivity and net foreign assets, but, at odds with the conventional wisdom, depreciates with higher government expenditures given that an increase in expenditures usually translates into higher imports and weaker current account position. In light of the projected real shocks associated with the depletion of oil and the change in other fundamentals in the context of the ongoing transition to a market economy, a more flexible regime would serve Syria better in the future.

Equilibrium Non-Oil Current Account Assessments for Oil Producing Countries

This paper introduces a methodology for assessing external balance in countries with large stocks of non-renewable resources based on oil stock data, and applies it to selected oil producing countries. The methodology uses a stock approach (instead of the more traditional flow approach) to estimate the equilibrium non-oil current account consistent with optimal consumption smoothing. One of the benefits of the stock approach is that geological data for oil reserves can be used to estimate oil wealth; however, the methodology makes the estimated non-oil current account norm very sensitive to oil price projections. Based on an oil price about US$70 per barrel prevailing in the summer of 2007, the baseline estimates indicate that the non-oil current accounts for most of the countries in the sample are broadly in equilibrium. By the same token, using oil price projections as of the summer of 2008 implies large disparities between the equilibrium non-oil current account position and the medium term forecast for all countries in the sample except for Malaysia.

A (Lack of) Progress Report on China's Exchange Rate Policies

This working paper assesses the progress made in improving China's exchange rate policies over the past five years (that is, since 2002). I first discuss four indicators of progress on China's external imbalance and its exchange rate policies - namely, the change in (and level of) China's global current account position, movements in the real effective exchange rate of the renminbi (RMB), the role of market forces in the determination of the RMB, and China's compliance with its obligations on exchange rate policy as a member of the International Monetary Fund (IMF). I then discuss why the lack of progress in improving China's exchange rate policies matters for the economies of the China and the United States and for the international monetary and trading system. I also argue that several popular arguments and excuses for why more cannot be accomplished on removing the large undervaluation of the RMB are unpersuasive. Finally, I consider what can and should be done by China, the United States, and the IMF to accelerate progress over the next year or two.

ANALYSIS OF THE CURRENT ACCOUNT POSITION OF FOUR ASIAN COUNTRIES BEFORE THE 1997 CRISIS

Abstract. The current paper presents an empirical analysis of the current account positions during the pre Asian crisis period, in the four most crisis‐hit countries (namely Thailand, the Philippines, South Korea and Indonesia). We have employed the procedures advocated by Husted for the presence of stationarity in current accounts by estimating a cointegration relationship between any country's exports and imports. The results do not substantiate the presence of cointegration between the series, implying that the macroeconomic fundamentals in these countries prior to the crisis were far from robust, at least from the perspective of current account sustainability.

Current Account Dynamics in OECD Countries and in the New EU Member States: An Intertemporal Approach

This paper investigates the large current account deficits observed in most new EU member states using an intertemporal model. The standard model is extended to include: (1) the persistence of current account positions and (2) the relevance of the fiscal balance. Specifically, a closed form solution for consumption in the presence of habit persistence and liquidity constraints is derived, yielding a dynamic model for the current account where fiscal deficits have an effect. The model is estimated for a panel of 33 countries. A key finding is that current accounts in most new EU member states are broadly in line with their structural current account positions.

Pathways Through Financial Crisis: India

India survived near-crisis situations twice in the 1990s. How did internal and external constraints shape that country's ability to respond to the crises? This article argues that India's success can be attributed to four sets of decisions taken during the period 1991-1997: devaluation, involvement of the IMF, partial liberalization of the domestic financial sector, and gradual opening up of the external sector. The article analyzes the options, political opposition, and eventual outcomes for each set of decisions. India's ownership of its reform program helped set the pace of reform, while close interaction between technocrats and the IMF added credibility. But the balance between entrenched traditional interest groups and the demands of new interests determined the scope of reform. KEYWORDS: India, financial crisis, economic reform, IMF, interest groups. ********** India survived near-crisis situations twice in the 1990s, and in 1991 was nearly bankrupt. In response, a reform process began. Engagement with the International Monetary Fund (IMF) had its risks: if India could not deliver on its promises of economic reform, investors would exit again; if the government pushed too hard on reforms, domestic opposition would become unmanageable. In 1997-1998 the Asian financial crisis again threatened India. Macroeconomic fundamentals were vastly different, but political instability and external shocks were common in both episodes. How did internal and external constraints shape India's ability to handle financial crises in the 1990s? The 1991 Crisis In 1991, India experienced a classic external payments crisis: high fiscal and current account deficits, external borrowing to finance the deficits, rising debt service obligations, rising inflation, and inadequate exchange rate adjustment. In 1979, the oil shock, agricultural subsidies, and a consumption-driven growth strategy had pushed up the fiscal deficit. It further increased in the mid-1980s as defense expenditure was substantially increased and direct taxes were progressively reduced. (1) The result was that the deficit ballooned from 1985 to reach 9.4 percent by 1990-1991. (2) India's current account position also worsened. Increasing dependence on foreign oil imports, vulnerability to oil price fluctuations, declining remittances from abroad, strong domestic demand (a result of public sector wage increases in the mid-1980s), and rising debt service payments ensured that the current account deficit averaged 2.2 percent of gross domestic product (GDP) during 1985-1990. Also, export competitiveness was adversely affected by the rupee's steady appreciation: 20 percent between 1979 and 1986. (3) In 1987 it steadily depreciated, but the real exchange rate remained overvalued until 1991. To finance the twin deficits, India relied on external funds. Foreign investment at 0.1 percent of GDP during 1985-1990 was negligible. (4) During 1980-1985, nearly half of external financing needs were met by external assistance. (5) By the mid-1980s, aid weariness forced the government to rely more on commercial borrowing. (6) Soft loans declined in proportion from 89 percent (1980) to 35 percent (1990). (7) Thus, external debt (with a large proportion of short-term debt) started dominating the balance sheet, peaking at 38.7 percent of GDP in 1991-1992, with the debt-export ratio at 563 percent. (8) Notwithstanding the weakening fundamentals, one key factor that reduced vulnerability was the absence of private sector external debt. Unlike many other countries, individuals and firms could not raise foreign currency-denominated debt, and the banking sector was not allowed to hold financial assets abroad. One effect of this was that the private sector's interests were geared more toward internal deregulation than toward external liberalization. (9) Two immediate external shocks contributed to the large current account deficit of 3. …

The Size and Sustainability of the Nigerian Current Account Deficits

This paper uses two different criteria -- a set of macroeconomic indicators and the intertemporal model of the current account -- to examine the excessiveness and sustainability of Nigerian current account deficits over the period 1960-2003. Our analysis shows excessive reliance on oil revenues, misperception of temporary increases in oil prices as permanent ones and structural weaknesses of the economy resulting in unsustainable current account deficits and external crisis, necessitating the adoption of the Structural Adjustment Program in 1986. However, both the macroeconomic indicators and the intertemporal model point to an improved current account position over the past decade. The paper also presents empirical results from the application of the Present Value Model of the Current Account (PYMCA) to Nigeria. Comparison of the estimated optimal and actual current account balances shows several years with excessive current account deficits. Further, these excessive current account deficits were driven by consumption tilting.

Global Realignment of Exchange Rates: East Asia's Dilemma

Over the past year East Asia has featured prominently in the international debate over the widening global economic imbalances. In particular, China has attracted much attention for the nature of its currency regime and its large trade surplus. Until recently, China pursued a strict policy of tightly fixing the value of the renminbi against the US dollar and, as a result, Chinese exports have remained highly competitive while the US current account position has deteriorated markedly. A substantial widening of China's trade surplus in the first half of this year has sparked a great deal of criticism from the US regarding China's exchange rate regime. Protectionist threats from the US and growing domestic imbalances in the Chinese economy have succeeded in prompting the Chinese authorities to reform their exchange rate regime. On 21 July, Chinese authorities announced the abandonment of the longstanding US dollar peg in favour of a managed system where the renminbi is fixed against a basket of currencies. The specifics of this new exchange rate regime provide ample scope for further renminbi appreciation; however, this will be an orderly and drawn-out process dictated by both economic and market conditions.

Australia's Medium-Run Exchange Rate: A Macroeconomic Balance Approach*

The determinants of Australia's exchange rate based on the internal–external balance approach introduced by Williamson (1983) were analysed. Internal balance implies that the economy is operating at supply potential with no inflationary pressures. External balance is characterised as the sustainable net flow of resources (corresponding to a current account to gross domestic product ratio) between countries in internal balance. After estimating a disaggregated trade model for Australia, estimates of the medium-term exchange rate associated with a given current account position were provided. These estimates, however, vary considerably through time because of variations in key parameters.

Determinants of Current Account Developments in the Central and East European EU Member States - Consequences for the Enlargement of the Euro Area

The current accounts of most EU member states in central and eastern Europe have been showing growing deficits in recent years. According to panel estimates the deficits can be attributed primarily to factors characteristic for the stage of development, ie the relative income level and high capital building. The positive impact of a closing income gap, however, is largely compensated by real appreciation. The net effect of government budget deficits is rather small, since they are mostly financed by private saving. Further integration of the financial sector is likely to improve the current accounts. Although the current account positions do not require fundamental policy reversals, there are clear risks of exchange rate adjustments that should be reduced before entering the euro area.

Determinants of Trade Policy Reform in Sub-Saharan Africa

Existing studies of trade reform in Sub-Saharan Africa (SSA) -- and elsewhere -- are mainly qualitative in character, partly because of the difficulty of measuring the intensity of trade liberalisation. This paper uses a quantitative measure of trade liberalisation to provide statistical evidence on the conditions accounting for Africa's timid reforms. This measure captures the change in the tariff equivalent of all trade barriers and is therefore a summary indicator of the intensity of reform. The measure provides a fairly accurate description of the trade liberalisation experience of SSA countries, indicating that the most significant reforms occurred during the period 1986--90. The empirical model includes a set of hypotheses suggested both by theory and the anecdotal evidence of Africa's liberalisation experience. The empirical methodology distinguishes between the conditions that affect the likelihood of reform and the factors that determine the intensity of trade liberalisation. The empirical results justify this distinction. The findings suggest that larger aid flows, higher levels of urbanisation, a strong current account position and a relatively large manufacturing sector enhance the probability that trade reform is adopted. There is also some evidence that economic crises facilitate reform. Conversely, heavier fiscal dependence on trade taxes, greater import competition and a large government make trade reform less likely. However, only five of these factors -- current account balance, size of manufacturing sector, size of government, fiscal dependence on trade taxes and aid -- are found to exert a statistically significant effect on the intensity of trade reform. Copyright 2003, Oxford University Press.

Growth Expectations, Capital Flows and International Risk Sharing

Over the past decades, cross-border financial flows have increased in importance and have in many occasions exceeded the underlying current account positions. This phenomenon has been accompanied by an increase in the volume of international equity transactions that accentuate the role of international risk sharing as a factor for the macroeconomic response to shocks. We use a stylised two-bloc, two-period model of the global economy, with a simple stochastic productivity shock affecting only one country. Efficient global risk-sharing imply that expected productivity gains in one country will attract equity inflows in excess of those needed to finance the current account. Upward-biased expectations about prospects for the productivity gains can further increase the risk exposure of foreign shareholders. The model is calibrated to show how ex post market losses - whether due to normal stock market downturn or ex ante over-optimism - are distributed and how they affect global consumption and current account positions. The results suggest that international spill over effects of stock market bubbles can contribute to business cycle synchronisation across economic areas.

Lessons of the Asian Financial Crisis: What Can an Early Warning System Model Tell Us?

Using an early warning system model, this paper provides empirical evidence on the causes of the 1997 Asian financial crisis, with a view to shedding light on policy lessons. The model shows that there were warning signals of heightened economic and financial vulnerabilities in each of the five most affected countries prior to the crisis, suggesting that weaknesses in economic and financial fundamentals in these countries played an important role in causing the crisis. The warning signals point to fundamental weaknesses, including real appreciation of domestic currencies, deterioration in current account positions, excessive external borrowing by banks and currency mismatches in their balance sheets, excessive growth of domestic credit, economic slowdown, and burst of asset price bubbles.

Current Account Deficits in the Euro Area: The End of the Feldstein-Horioka Puzzle?

IN 2000-01 THE CURRENT account deficit of Portugal reached 10 percent of its GDP, up from 2-3 percent at the start of the 1990s. These deficits are forecast to continue in the 8-9 percent range for the indefinite future. Greece is not far behind. Its current account deficit in 2000-01 was equal to 6-7 percent of GDP, up from 1-2 percent in the early 1990s, and again, the forecasts are for deficits to remain high, in the 5-6 percent range. This is not the first time that some of the small member countries of the European Union have run large current account deficits. In the early 1980s, for example, Portugal ran deficits in excess of 10 percent of GDP. But those deficits had a very different flavor from today's: Portugal then was still reeling from its 1975 revolution, from the loss of its colonies, and from the second oil shock; the government was running a large budget deficit, in excess of 12 percent of GDP. The current account deficits were widely perceived as unsustainable, and indeed they turned out to be: between 1980 and 1987, the escudo was devalued by 60 percent, and the current account deficit was eliminated. In contrast, Portugal today is not suffering from large adverse shocks; the official budget deficit has been reduced since the early 1990s (although with some signs of relapse in 2002, as current estimates imply that Portugal may exceed the limits imposed by the 1997 Stability and Growth Pact among the countries participating in European monetary union); and financial markets show no sign of worry. The fact that both Portugal and Greece are members of both the European Union and the euro area (the group of countries that use the euro as their common currency), and the fact that they are the two poorest members of both groups, suggest a natural explanation for today's current account deficits. They are exactly what theory suggests can and should happen when countries become more closely linked in goods and financial markets. To the extent that they are the countries with higher expected rates of return, poor countries should see an increase in investment. And to the extent that they are the countries with better growth prospects, they should also see a decrease in saving. Thus, on both counts, poorer countries should run larger current account deficits, and, symmetrically, richer countries should run larger current account surpluses. This paper investigates whether this hypothesis indeed fits the facts. We conclude that it does, and that saving rather than investment is the main channel through which integration affects current account balances. We proceed in four steps. First, we use a workhorse open-economy model to show how, for poorer countries, goods and financial market integration are likely to lead to both a decrease in saving and an increase in investment, and so to a larger current account deficit. We also discuss how other, less direct implications of the process of integration, such as domestic financial liberalization, are likely to reinforce that outcome. Second, we look at panel data evidence from the countries of the Organization for Economic Cooperation and Development (OECD) since 1975. We document that the recent changes in the current account balances of Portugal and Greece are indeed part of a more general trend: the dispersion of current account positions among OECD countries has steadily increased since the early 1990s, and current account positions have become increasingly related to countries' income per capita. This trend is visible within the OECD as a whole but is stronger within the European Union, and stronger still within the euro area. The channel through which this occurs appears to be primarily a decrease in saving--typically private saving--in the countries with widening current account deficits, rather than an increase in investment. Third, we return to the cases of Portugal and Greece. …

Terms of Trade Shocks and the Current Account: Evidence from Five Industrial Countries

What is the effect of shocks to the terms of trade on a country's current account position? The Harberger-Laursen-Metzler effect predicts that an adverse shock to the terms of trade will worsen the current account balance; in contrast, the prediction of intertemporal models of the current account is dependent on the duration of the shock. This paper examines several features of the terms of trade series of five OECD countries, and the relationship between terms of trade shocks and the current account balance. Median shocks to the terms of trade are found to be highly persistent, yet with a large transitory component, and to account for only a small share of the variability of current account balances in Canada, the United Kingdom, and the United States. In contrast, terms of trade shocks are found to account for a relatively large proportion of the variability of current account balances in Australia and New Zealand.