Sharp Reductions in Current Account Deficits: An Empirical Analysis
.Sharp Reductions in Current Account Deficits: An Empirical Analysis.
by Gian Maria Milesi-Ferretti and Assaf Razin
The European Monetary System (EMS) crisis of 1992-93, the Mexican experience
and, more recently, the currency crisis in Thailand have put the causes of
sudden reversals in the direction of capital flows and of currency crises at
the center of the policy debate in both industrial and developing countries.
For developing countries in particular, an important issue is whether large and
persistent current account imbalances are a sign of future external problems.
The episodes mentioned above have been the subject of a large number of
studies; however, no comprehensive cross-country study of sharp reductions in
current account imbalances has so far been undertaken. The research project on
which this paper is based attempts to fill that gap. This paper reports early
results from a study of determinants and consequences of reversals in current
account imbalances in low- and middle-income countries over the period 1971-92.
Two key questions are addressed: First, what triggers sharp reductions in
current account deficits? Second, what factors explain how costly such
The main findings of the paper are that both domestic variables -- such as the
current account balance, openness to trade, and the level of reserves -- and
external variables -- such as terms of trade shocks, U.S. real interest rates,
and growth in industrial countries -- seem to play important roles in
explaining reversals in current account imbalances. It is also found that
reversals are not necessarily associated with a slowdown in growth. Countries
that before the event had a less appreciated real exchange rate, higher
investment, and more trade openness tend to grow faster after a reversal