What Determines the Current Account? A Cross-Sectional and Panel Approach

WP/96/58-EA

What Determines the Current Account? A Cross-Sectional
and Panel Approach by Guy Debelle and Hamid Faruqee


Persistent external imbalances among industrial and developing
countries in recent years continue to provide impetus for examining
issues surrounding the determination and sustainability of current
account positions. Why do some countries experience chronic current
account deficits, and why are some imbalances a cause for greater concern
than others?

The purpose of this paper is to explore the factors that may affect
the long-run determination of the current account in a broad cross section
of countries. From a policy perspective, a better understanding of the
factors underlying longer-term developments in the current account is
central to assessing whether policies aimed at attaining domestic economic
objectives are compatible with a sustainable external position.

The empirical analysis examines to what extent a common set of
underlying determinants has been relevant historically in explaining current
account balances across countries and over time. Using economic theories of
saving and investment as a guide, the analysis investigates the role of the
stage of development, demographics, macroeconomic policies, and other
considerations in underpinning sustained current account positions.

The paper uses two approaches to estimate the determinants of current
account positions. The first approach uses cross-sectional data, whereby
each country's average current account position is assumed to approximately
reflect a long-run equilibrium outcome. The second approach uses panel data
on a sample of industrial countries. Short-run variables are used to find
that current account positions are not necessarily in long-run equilibrium
in each time period. Within the panel approach we estimate a partial
adjustment model of the current account and an error-correction model of net
foreign assets.

Using the cross-sectional approach, we find that the stage of
development and demographics have a significant impact (in most cases) on
current account positions. When we turn to the more dynamic approach of the
partial adjustment or error-correction model, we find that fiscal policy has
a large impact on the current account. Deteriorations in the fiscal
position are associated with deteriorations in the current account or net
foreign assets (although not one-for-one). We also find a significant
impact of short-run variables such as real exchange rate changes, the stage
of the cycle, and terms of trade changes, in addition to the long-run impact
of stage of development and demographics (in general). The error-correction
specification suggests that the half life of a shock to the equilibrium net
foreign asset position is about six or seven years.