Title: ACADEMY OF ECONOMIC STUDIES DOCTORAL SCHOOL OF FINANCE AND BANKING Determinants of current account: an intertemporal approach Dissertation Paper
1ACADEMY OF ECONOMIC STUDIESDOCTORAL SCHOOL OF
FINANCE AND BANKINGDeterminants of current
account an intertemporal approach
Dissertation Paper
- Student GALINA GHERMAN
- Supervisor Professor MOISA ALTAR, PhD
- BUCHAREST, JULY 2007
2Contents
- Introduction
- Literature Review
- Theoretical model of the current account an
intertemporal approach - Data analysis and estimation methodology
- Results
- Concluding remarks
- References
3I. Introduction
- Main Objectives
- To provide an empirical linkage between current
account deficit and a broad set of economic
variables proposed by theoretical and empirical
literature - To study the current account dynamics and derive
structural current account position
4II. Literature Review
- The standard intertemporal current account model
was proposed by Sachs (1981) and extended by
Obstfeld and Rogoff (1995,1996). In accordance
with this model, the current account deficit is
sustainable if it reflects the expectation of
private agents and Ricardian equivalence holds. - Campbell and Mankiw (1991) reveal the consumption
decision determined by the changes in current and
permanent income. - Glick and Rogoff (1995) study the impact of
global versus country-specific productivity
shocks on investment, respectively on current
account.
5II. Literature Review
- Debelle and Faruqee (1996) make a difference
between factors which have an impact in short and
long run. Thus the real effective exchange rate,
business cycle and term of trade are shown to
have a short run effect, while the stage of
development and demographics have long run
effects. The fiscal balance has a significant
impact on current account in short and long run. - Milesi-Ferretti and Razin (1996). The paper
focuses on the issue that the current account
sustainability has to be viewed from different
angles exchange rate policy, structural
indicators as the level of openness, the level of
savings and investments, financial system
weaknesses.
6II. Literature Review
- Roubini and Wachtel (1998) reveal the criteria
which has to be taken into account in order to
assess the sustainability of current account
deficit. They argue that a large current account
deficit has to be tackled in the context of
different variables weak banking and financial
system, large fiscal imbalances, low foreign
reserves, increasing foreign debt. - Chinn and Prasad (2003) carry out an empirical
investigation on determinants of current account.
The model is estimated on a sample which includes
the industrial and developing countries. They
find that the fiscal balance and the initial
stocks of net foreign assets are positively
correlated with current account, while indicators
of openness to international trade are negatively
correlated with current account balance. -
7III. Theoretical model of the current account an
intertemporal approach
- The extended intertemporal current account model
was studied by Bussiere, Fratzscher and Muller
(2004) and Zanghieri (2004). - The model includes two stylized facts
- The persistence of current account
- The relevance of fiscal balance
- Assume that in the economy are three categories
of agents - Private sector, which includes
- Non-Ricardian agents
- Ricardian agents
- Public sector presented by the Government
8III. Theoretical model of the current account
an intertemporal approach
- Private sector
- 1. Non-Ricardian agents
- 2. Ricardian agents
-
- Subject to
- no-Ponzi game condition
9III. Theoretical model of the current account an
intertemporal approach
- Aggregate consumption of private sector
- Substituting each terms from the equation, we
obtain aggregate consumption of private sector
10III. Theoretical model of the current account an
intertemporal approach
- In accordance with Obstfeld and Rogoff
(1995,1996) a countrys current account balance
over a period is the change in the value of its
net claims on the rest of the world the changes
in its net foreign assets. - Where the total net foreign assets position is
given by the sum of private and government
assets - On the other side, current account corresponds to
the sum of net income and the net output minus
aggregate consumption
11III. Theoretical model of the current account an
intertemporal approach
- From the formula above, it results
- The equation of current account through
saving-investment perspective - The dynamic equation of current account
12IV. Data analysis and estimation methodologies
- Our investigation is based on a sample of 27
countries - EU 15
- 10 acceding countries (2004), excluding Malta
and Cyprus - Romania and Bulgaria (2007)
- Croatia and Turkey
- Data sources
- Eurostat
- World Economic Outlook, provided by IMF
- AMECO
- For all countries we use data from 1995 2005.
13IV. Data analysis and estimation methodologies
- The dynamic model
- The dependent variable
- Current account
- The independent variables
- One lag current account
- Fiscal balance
- Relative income
- Relative investment ratio
- Relative public spending ratio
- Real effective exchange rate
14IV. Data analysis and estimation methodologies
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- For a R square of 0.41, there is a negative
relation between current account and relative
investment ratio.
- For a R square of 0.11, there is a positive
relation between current account and relative
income.
15IV. Data analysis and estimation methodologies
- For a R square of 0.13, there is a positive
relation between current account and fiscal
balance.
- For a R square of 0.005, there is a positive
correlation between current account and changes
in net output.
16IV. Data analysis and estimation methodologies
- For a R square of 0.12, there is a positive
relation between current account and relative
public spending ratio.
- For a R square of 0.008, there is a negative
relation between current account and real
effective exchange rate.
17IV. Data analysis and estimation methodologies
- We use three estimation strategies
- Least Squares Dummy Variables
- Two Stage Least Squares
- Generalized Method of Moments
18V. Results
- 5.1. Presentation of the short run impact on
current account - Least Squares Dummy Variables
19V. Results
- 5.1. Presentation of the short run impact on
current account - Two Stage Least Squares
20V. Results
- 5.1. Presentation of the short run impact on
current account - Generalized Method of Moments
21V. Results
- 5.2. Analysis of results
- The lagged current account
- positive relation
- the coefficient of the lagged current account
is 0.66 - the persistence of current account
- Fiscal balance
- positive relation
- the immediate impact is 0.086
- the relevance of fiscal balance
22V. Results
- 5.2. Analysis of results
- Changes in net output
- positive relation
- the coefficient is 0.25
- explanation 75 of an increase in net output
is consumed, while 25 is saved, and
respectively reflected in current account - Relative income
- positive relation
- the coefficient in the short run is 0.039
- the positive coefficient on relative income
indicates that a per capita income below the
average EU 15 will be associated with a current
account deficit
23V. Results
- 5.2. Analysis of results
- Relative investment
- negative relation
- the immediate impetus is -0.27
- if investment is above its permanent level, an
increase in this ratio will induce a current
account deficit - Relative public spending
- we found a positive relation between current
account and relative public spending ratio - the immediate impact is 0.06, which is not
significant - if public spending ratio is above permanent
level an increase in this ratio will induce a
current account deficit
24V. Results
- 5.3. Presentation of results (including REER in
the model) - Least Squares Dummy Variables
25V. Results
- 5.3. Presentation of results (including REER in
the model) - Two Stage Least Squares
26V. Results5.3. Presentation of results
(including REER in the model)
- Real effective exchange rate
- negative relation
- the immediate impact is about -0.016
- an appreciation in REER will lead to a loss of
competitiveness, and a large current account
deficit
- Generalized Method of Moments
27V. Results5.4. Presentation of the long run
impact on current account
- Generalized Method of Moments
- Here we include the variables, which have a long
run impact on current account - Fiscal balance the impact is much larger than
in the short run. The coefficient is 0.32. - Relative income in the long run any increases
in relative income will lead to an increase in
current account by 0.087. - Relative investments ratio has a negative effect.
The coefficient is about 0.71.
28V. Results5.4. Presentation of the long run
impact on current account
- We also found that public spending ratio and real
effective exchange rate would have an impact on
long run. - REER has no such a huge influence neither in the
long run. The coefficient is about - -0.05.
- Concerning to public spending ratio, it might
have a long run impact. The coefficient is about
0.16.
- Generalized Method of Moments
29V. Results5.5. Structural current account
position
- As we can see from this graph, Romania has an
increasingly large current account deficit. - Which are the causes of such large current
account deficit?
30V. Results
- The high level of investment ratio is due to
- Favorable climate for foreign investments
- High level of capital inflow determined by the
accession in EU of Romania - The need of investments in order to restructure
different sectors - For the saving ratio, from 2002 we find a
downward evolution in the context of an increase
in consumption.
31VI. Concluding remarks
- The current account is persistent by including
in the model the lagged current account, the
coefficient reaching a value of 0.67. - Fiscal balance has a positive effect on current
account. Thus in the short run a raise in fiscal
balance will cause a raise in current account
position. The coefficient in short run is about
0.08. In the long run the influence is much more
significant, reaching a value of 0.32. - Changes in net output will lead to an increase in
current account through savings. The coefficient
on the changes in the net output of around 0.25.
This variable is explained as follows 75 of an
increase in net output is consumed, and just 25
is saved and reflected in current account.
32VI. Concluding remarks
- An income below the permanent level is
associated with a current account deficit. In the
short run relative income is reflected by a
coefficient of 0.039. In the long run, the
influence is larger, reaching a value of 0.087. - The increase in relative investment ratio will
lower the current account deficit. If investment
ratio is above the permanent level, presented
by the average of EU 15, it will lead to a larger
current account deficit. In the short run the
coefficient is about -0.27, while in long run
-0.71.
33VI. Concluding remarks
- Relative public spending ratio has a positive
effect on current account deficit. From our
estimation, we found a positive relation between
relative public spending and current account. If
public spending ratio is above the permanent
level, an increase in this variable will lead to
an increase in current account by a coefficient
of 0.06. - An appreciation of real effective exchange rate
will lead to a loss of competitiveness inducing a
larger current account deficit. The coefficient
of this variable is -0.016
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38THANK YOU!