## 11. Correlation Between Changes in the Current and Financial Balances and Underlying Components

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---

### Introduction and scope
- Sample: nine industrial countries—Australia, Canada, Denmark, France, Germany, Italy, New Zealand, Sweden, and the United Kingdom.
- Time span for displayed averages in Figure 1: 1972-2003 (Figure 1 caption: "Average Ratio of Current Account Balance to GDP (1972-2003) (In percent)").
- Questions addressed:
  - What factors determine fluctuations in the current account balance over time?
  - What are the effects of domestic business cycles, relative competitiveness, and trading-partner conditions on cyclicality of the current account?
  - How do the current and financial accounts co-move, and what determines their cyclicality?

### Data patterns and stylized facts
- Countries with notable deficits for much of 1979–2003: Australia, Canada, New Zealand, and the United Kingdom.
- Country-specific current account ranges:
  - Australia: deficit ranging from a low of 1.9 percent of GDP in 1979 to a high of 6.1 percent in 1989.
  - New Zealand: deficit ranging from a low of 0.95 percent of GDP in 1988 to a high of 8.90 percent of GDP in 1984.
  - United Kingdom: deficit ranging from a low of 0.16 percent of GDP in 1985 to a high of 5.12 percent of GDP in 1989.
  - United States (example cited): ranged from 0.8 percent in relation to GDP in 1992 to 4.5 percent in 2000.
- General observation: absolute size and sign of the current account balance varied significantly over business cycles; many countries experienced cyclical shifts including sign changes.

### Theoretical framework and key hypotheses
- Accounting identity: a deficit in the current account must be associated with an increase in the financial balance (excluding reserves) or a reduction in official reserves.
- Hypothesized channels and expected signs:
  - Domestic real output growth: expected negative impact on the current account (boom → higher imports and investment → wider current account deficit).
  - Price inflation: ambiguous via scale effect (increases exports) and competitiveness/relative price effect (reduces exports); expected to increase imports.
  - Real effective exchange rate (REER) appreciation: expected to worsen the current account by reducing competitiveness (J-curve caveat noted).
  - Energy price increases: effect depends on oil-exporting vs. importing status; may increase imports for oil importers, but could raise exports via demand from oil-producing countries.
  - Financial account: higher domestic growth and better investment opportunities expected to attract financial inflows; REER appreciation has ambiguous effects on inflows (valuation vs. signaling).
- Relation between accounts: abstracting from capital-account and omissions/errors, an inverse relationship is expected between current and financial accounts—fluctuations should carry opposite signs.

### Empirical strategy
- Two-step approach:
  1. Non-stationarity and cointegration testing.
  2. Estimation of reduced-form equations (first-difference specification) for:
     - current account balance,
     - exports of goods and services (log),
     - imports of goods and services (log),
     - financial account balance,
     - financial inflows (log),
     - financial outflows (log).
- Explanatory variables:
  - Domestic: real GDP growth (disaggregated into anticipated and unanticipated components), GDP deflator (price inflation), rate of appreciation in REER, energy price inflation.
  - External: real output growth in the United States (DyUS) and proxy for growth in major trading partners (DyMT: euro area for European countries; Australia for New Zealand; Japan for Australia).
- Error-correction: where cointegration is found, include lagged residual from cointegration regression (1t EC−).
- Empirical model (first-difference specification) summarized in the source:
  - Dependent variable X (changes) related to domestic and foreign fluctuations, with anticipated growth represented by 1t EDy− and an error-correction term 1t EC− where appropriate.

### Non-stationarity and cointegration findings
- Non-stationarity test summary (variables tested include real GDP, GDP deflator, energy prices, REER, current account balance, exports, imports, financial account balance, inflows, outflows):
  - Australia: all variables non-stationary except REER, current account balance, and financial account balance.
  - Canada: all variables non-stationary except financial inflows.
  - Denmark: all variables non-stationary except financial outflows.
  - France: all variables non-stationary except real GDP.
  - Germany: all variables non-stationary except the current account balance.
  - Italy: all variables non-stationary except real GDP, current account balance, financial account balance, and inflows.
  - New Zealand: all variables non-stationary except the financial account balance and inflows.
  - Sweden: all variables non-stationary except REER, financial inflows and outflows.
  - United Kingdom: all variables non-stationary.
- Cointegration relations:
  - Evidence of common stochastic trends between financial and current account balances in: Canada, Denmark, France, Sweden, and the United Kingdom.
  - Australia: financial and current account balances not cointegrated, but their underlying components exhibit a common stochastic trend.
  - Germany: financial balance and its underlying components exhibit a common stochastic trend with components of the current account balance.
  - Italy: only outflows exhibit a common stochastic trend with exports and imports.
  - New Zealand: only outflows exhibit a common stochastic trend with the current account balance and its underlying components.
  - Overall: strong long-run relationship between current and financial accounts or their components in a majority of cases.

### Main reduced-form results: determinants of cyclical fluctuations
- Current account balance:
  - Anticipated real output growth decreases the current account balance significantly in one country: Germany.
  - Unanticipated real output growth decreases the current account balance significantly in three countries: Denmark, France, and New Zealand.
  - Unanticipated real output growth increases the current account balance significantly in one country: Italy.
  - Bulk evidence: current account moves counter-cyclically with economic growth, and the relationship is mostly transitory.
  - No evidence of a significant effect of price inflation or the real exchange rate on the current account balance in any country in the sample.
- Financial account and components:
  - Higher domestic growth associated with improvements in the financial balance (inflows) in principle; country-specific results detailed in Tables 2–10 of the source.
  - REER movements and energy price changes have ambiguous effects on financial balances (valuation vs. signaling; inflows from oil-producing countries).
- Joint behavior in cyclical episodes:
  - Domestic-growth-induced fluctuations are a major joint source: during a boom, domestic absorption exceeds GNI → current account deficit; higher growth stimulates financial inflows → improved financial account.
  - A current account deficit driven by investment-financed growth is less worrying if investment yields returns above required returns to international investors.
  - A deficit driven by fiscal deterioration is potentially more problematic (twin-deficit concern).

### Appendix I) — Determinants of fluctuations (key country-level results)
- Current account determinants:
  - Energy price increases the current account balance significantly in two countries: Australia and Canada.
  - United States growth improves the current account balance significantly in one country: France.
  - Euro-area growth worsens the current account balance significantly in one country: Italy.
  - Overall: fluctuations in real output growth are relatively more important to cyclicality of the current account balance; many fluctuations are unsystematic.
- Export growth determinants:
  - Anticipated growth increases exports significantly in two countries: New Zealand and the United Kingdom.
  - Unanticipated growth increases exports significantly in two countries: New Zealand and Sweden.
  - Price inflation increases export growth significantly in seven countries: Canada, Denmark, France, Italy, New Zealand, Sweden and the United Kingdom (scale effect stronger than relative price channel).
  - Energy price increases export growth in four countries: Denmark, New Zealand, Sweden, and the United Kingdom.
  - REER appreciation decreases export growth significantly in six countries: Australia, Canada, Denmark, France, New Zealand, Sweden, and the United Kingdom.
  - Growth in the United States stimulates export growth in one country: Sweden.
  - Major trading-partner growth does not significantly affect export growth in any country.
- Import growth determinants:
  - Anticipated growth increases imports significantly in two countries: Australia and the United Kingdom.
  - Unanticipated growth increases imports significantly in four countries: Australia, Denmark, New Zealand, and Sweden.
  - Domestic price inflation increases imports significantly in four countries: Canada, France, Italy and New Zealand.
  - Energy price increases imports significantly in five countries: France, Germany, Italy, New Zealand, and the United Kingdom.
  - Currency depreciation increases imports in six countries: Canada, Denmark, France, Italy, New Zealand, and Sweden (consistent with a J-curve effect).
  - United States growth increases imports significantly in one country: Canada.
  - Overall: imports are highly dependent on domestic growth and price inflation; short-run exchange-rate movements are not effective to induce necessary changes in imports under flexible exchange rates.
- Financial balance determinants:
  - Anticipated growth generally not significant (except Germany).
  - Financial balance improves significantly with unanticipated growth in two countries: Denmark and France.
  - No evidence of a significant effect of domestic inflation on the financial balance in any country.
  - Energy price has a statistically significant negative effect on the financial balance only in Australia.
  - REER effect limited: significant only for Sweden.
  - United States growth generally not significant; euro-area growth improves financial balance in Sweden.
  - Overall: financial balance exhibits high randomness and limited explanation by cyclical domestic and external variables.
- Financial inflows and outflows:
  - Anticipated growth does not determine financial inflows significantly in any country.
  - Unanticipated growth increases financial inflows significantly in one country: Australia.
  - Price inflation significantly increases financial inflows in one country: Italy.
  - Financial inflows decrease significantly with currency appreciation in one country: New Zealand.
  - United States growth associated with significant reduction in inflows in one country: Australia, and significant increase in another: Italy.
  - Anticipated growth decreases financial outflows significantly in one country: Canada.
  - Positive output shock decreases outflows significantly in one country: Germany.
  - Price inflation increases outflows significantly in one country: Italy.
  - United States growth increases financial outflows in two countries: Canada and Italy.
  - Overall: high degree of randomness associated with financial inflows and outflows; cyclical explanatory variables do not explain much.

### Correlations between financial and current accounts
- Time-series correlations (Table 11) between changes in current and financial accounts:
  - Correlation coefficients between changes in current and financial balances are negative and significant for all countries, ranging from -0.39 in Denmark to -0.96 in Australia (column (1) summary).
  - Australia correlation = -0.96* (probability of zero correlation reported as (0.0001) in Table 11).
  - Combined (all countries) correlation between responses to various shifts within countries equals -0.85 (Table 12.A).
- Correlations between current account and its components:
  - Current account change correlates positively and significantly with export growth in two countries: Australia and Sweden.
  - Current account change correlates negatively and significantly with imports in three countries: France, Germany, and New Zealand.
- Correlations between financial balance and its components:
  - Financial inflows correlate positively with the financial balance, significant in two countries: Canada and New Zealand.
  - Financial outflows correlate negatively and significantly with the financial balance in one country: Australia.
- Correlations between estimated parameter responses across countries (Table 12.B):
  - Domestic expected growth (EDy): correlation coefficient -0.97 (Probability of Zero Correlation (0.0001)).
  - Domestic unanticipated growth (Dys): coefficient -0.88 (Probability (0.002)).
  - Price inflation (Dp): coefficient -0.31 (Probability (0.41)).
  - Energy price (Denergy): coefficient -0.30 (Probability (0.43)).
  - Real exchange rate (Dreer): coefficient -0.48 (Probability (0.18)).
  - DyUS (United States growth): coefficient -0.0015 (Probability (0.99)).
  - DyMT (growth in major trading partners): coefficient -0.87 (Probability (0.0049)).
- Interpretation: domestic growth (anticipated and unanticipated) is a major determinant of the negative correlation between current and financial accounts.

### Summary and policy-relevant implications
- Main empirical conclusions:
  - Cointegration tests confirm long-term relationships between current and financial balances or their underlying components in most sample countries.
  - Correlation coefficient between current and financial accounts is negative; sustaining a significant current account deficit depends on accumulating net financial flows.
  - Real growth raises imports and therefore negatively impacts the current account.
  - No evidence that higher inflation adversely affects the current account; inflation appears positively associated with both exports and imports in sample countries.
  - For oil-importing countries, higher energy prices increase import values; exports also increase in some countries in response to higher energy prices.
  - Real currency appreciation reduces export growth; imports' response to exchange rate movement shows evidence of a J-curve in several countries.
  - Global or regional growth conditions do not have robust effects on import or export growth in the sample.
  - Financial account cyclical behavior is harder to predict; the model shows high randomness and limited explanatory power of included variables.
  - Reduced-form regressions indicate cyclical factors have a stronger effect on short-term fluctuations in the current account than in the financial account.
  - Domestic growth is the most important factor explaining current and financial balances and their negative correlations over time.
- Policy-relevant implications:
  - Current account deficits associated with domestic growth booms tend to be financed by contemporaneous financial inflows and are less concerning when funds finance productive investment.
  - Deficits associated with fiscal deterioration or non-growth fundamentals are potentially more problematic for sustainability.
  - The necessary and sufficient condition to sustain a large current account deficit is high growth that stimulates financial inflows and provides adequate resources for financing.
  - In the absence of high growth, sharp exchange rate movements (market-induced or policy-induced) may be necessary to correct widening current account deficits and achieve sustainable external balances.

### Key statistics and reported numeric magnitudes (selected)
- Country correlations between changes in current and financial balances:
  - Australia: -0.96* (probability (0.0001))
  - Canada: -0.86* (probability (0.0001))
  - Denmark: -0.39* (probability (0.043))
  - France: -0.84* (probability (0.0001))
  - Germany: -0.85* (probability (0.0001))
  - Italy: -0.61* (probability (0.0006))
  - New Zealand: -0.45* (probability (0.027))
  - Sweden: -0.49* (probability (0.010))
  - United Kingdom: -0.58* (probability (0.0016))
- Aggregate correlation across responses to various shifts within countries: -0.85 (Table 12.A, probability (0.0001)).
- Cross-country correlations between responses to specific shifts (Table 12.B):
  - EDy: -0.97 (probability (0.0001))
  - Dys: -0.88 (probability (0.002))
  - DyMT: -0.87 (probability (0.0049))
  - Dreer: -0.48 (probability (0.18))
  - Dp: -0.31 (probability (0.41))
  - Denergy: -0.30 (probability (0.43))
  - DyUS: -0.0015 (probability (0.99))

### Econometric methodology (appendix highlights)
- Expected growth constructed by regressing first difference of log real GDP on a constant, two lags of its own, two lags of first-difference of log GDP deflator, energy price, real effective exchange rate, and government expenditure; model reduction keeps variables significant at least at the 10 level. Shocks equal actual minus forecast.
- Expectation equations jointly estimated with the rest of the model using 3SLS; instrument list includes two lags of first-differences of representative short-term interest rate, log real GDP, GDP deflator, energy price, real effective exchange rate, DyUS, DyMT, money supply, and government spending.
- Serial correlation addressed by filtering empirical models with (1 − Lρ), where ρ is the serial correlation parameter; reported estimates are after transformation to eliminate serial correlation.

*Source: IMF Working Paper — chapter "11. Correlation Between Changes in the Current and Financial Balances and Underlying Components" (content unit provided).*

### References..............................................................................................................

### _wp0556 - References

### Figures
- Figure 1. Average Ratio of Current Account Balance to GDP (1972-2003).............................3

### Tables
- 1.   Current Account Balance Relative to Nominal GDP ........................................................22
- 2.   Determinants of Fluctuations in the Current and Financial Balances: Australia...............23
- 3.   Determinants of Fluctuations in the Current and Financial Balances: Canada .................24
- 4.   Determinants of Fluctuations in the Current and Financial Balances: Denmark...............25
- 5.   Determinants of Fluctuations in the Current and Financial Balances: France...................26
- 6.   Determinants of Fluctuations in the Current and Financial Balances: Germany...............27
- 7.   Determinants of Fluctuations in the Current and Financial Balances: Italy ......................28
- 8.   Determinants of Fluctuations in the Current and Financial Balances: New Zealand ........29
- 9.   Determinants of Fluctuations in the Current and Financial Balances: Sweden.................30
- 10. Determinants of Fluctuations in the Current and Financial Balances: United Kingdom ..31

*Source: _wp0556 - References (pages and figure/table titles as listed in the source PDF).*

### 11. Correlation Between Changes in the Current and Financial Balances and

### 11. Correlation Between Changes in the Current and Financial Balances and Underlying Components

### Introduction and scope
- Sample: nine industrial countries—Australia, Canada, Denmark, France, Germany, Italy, New Zealand, Sweden, and the United Kingdom.
- Time span for displayed averages in Figure 1: 1972-2003 (Figure 1 caption: "Average Ratio of Current Account Balance to GDP (1972-2003) (In percent)").
- Questions addressed:
  - What factors determine fluctuations in the current account balance over time?
  - What are the effects of domestic business cycles, relative competitiveness, and trading-partner conditions on cyclicality of the current account?
  - How do the current and financial accounts co-move, and what determines their cyclicality?

### Data patterns and stylized facts
- Countries with notable deficits for much of 1979–2003: Australia, Canada, New Zealand, and the United Kingdom.
- Country-specific current account ranges reported:
  - Australia: deficit ranging from a low of 1.9 percent of GDP in 1979 to a high of 6.1 percent in 1989.
  - New Zealand: deficit ranging from a low of 0.95 percent of GDP in 1988 to a high of 8.90 percent of GDP in 1984.
  - United Kingdom: deficit ranging from a low of 0.16 percent of GDP in 1985 to a high of 5.12 percent of GDP in 1989.
  - United States (example cited from related work): ranged from 0.8 percent in relation to GDP in 1992 to 4.5 percent in 2000.
- General observation: absolute size and sign of the current account balance varied significantly over business cycles; many countries experienced cyclical shifts including sign changes.

### Theoretical framework and key hypotheses
- Accounting identity: deficit in the current account must be associated with an increase in the financial balance (excluding reserves) or a reduction in official reserves.
- Key channels and hypothesized signs:
  - Domestic real output growth: expected to have a negative impact on the current account (boom → higher imports and investment → wider current account deficit).
  - Price inflation: ambiguous via a scale effect (increases exports) and a competitiveness/relative price effect (reduces exports); expected to increase imports.
  - Real effective exchange rate (REER) appreciation: expected to decrease competitiveness, increase imports, decrease exports → worsen the current account (J-curve caveat noted).
  - Energy price increases: effect depends on oil-exporting vs. importing status; may increase imports for oil importers, but also could raise exports via demand from oil-producing countries.
  - Financial account: higher domestic growth and better investment opportunities are expected to attract financial inflows and improve the financial balance; the REER appreciation can either increase or decrease financial inflows depending on valuation and signaling effects.
- Relation between accounts: abstracting from the (small) capital account and omissions/errors, an inverse relationship is expected between current and financial accounts—fluctuations should carry opposite signs.

### Empirical strategy
- Two-step empirical approach:
  1. Non-stationarity and cointegration testing.
  2. Estimation of reduced-form equations (first-difference specification) for:
     - current account balance,
     - exports of goods and services (log),
     - imports of goods and services (log),
     - financial account balance,
     - financial inflows (log),
     - financial outflows (log).
- Explanatory variables:
  - Domestic: real GDP growth (disaggregated into anticipated and unanticipated components), GDP deflator (price inflation), rate of appreciation in REER, energy price inflation.
  - External: real output growth in the United States (US_t Dy) and proxy for growth in major trading partners (euro area for European countries; Australia for New Zealand; Japan for Australia).
- Error-correction: where cointegration is found between non-stationary dependent and explanatory variables, an error-correction term (lagged residual from cointegration regression) is included.
- Empirical model (first-difference specification) as given in the source:
  - Let X be the dependent variable (current account balance, log exports, log imports, financial account balance, log inflows, or log outflows).
  - The model:
    01121
    ()
    tttttt
    DXab E   Dyb   DyE   Dy
    −−
    =++−

    3456    781
    USMTx
    ttttttt
    b Dpb Dreerb Denergyb Dyb Dyb ECν
    −
    ++  ++ +  + +.
  - Interpretation: changes in the dependent variable are related to domestic and foreign fluctuations, with anticipated growth represented by 1t EDy− (rational expectation forecasts given information available at time 1t−), and cointegration error-correction term 1t EC− included where appropriate.

### Non-stationarity and cointegration findings
- Non-stationarity test summary (variables tested include real GDP, GDP deflator, energy prices, REER, current account balance, exports, imports, financial account balance, inflows, outflows):
  - Australia: all variables non-stationary except REER, current account balance, and financial account balance.
  - Canada: all variables non-stationary except financial inflows.
  - Denmark: all variables non-stationary except financial outflows.
  - France: all variables non-stationary except real GDP.
  - Germany: all variables non-stationary except the current account balance.
  - Italy: all variables non-stationary except real GDP, current account balance, financial account balance, and inflows.
  - New Zealand: all variables non-stationary except the financial account balance and inflows.
  - Sweden: all variables non-stationary except REER, financial inflows and outflows.
  - United Kingdom: all variables non-stationary.
- Cointegration relations among current and financial accounts:
  - Evidence of common stochastic trends (cointegration) between financial and current account balances in: Canada, Denmark, France, Sweden, and the United Kingdom.
  - Australia: financial and current account balances are not cointegrated, but their underlying components exhibit a common stochastic trend.
  - Germany: financial balance and its underlying components exhibit a common stochastic trend with components of the current account balance.
  - Italy: only outflows exhibit a common stochastic trend with exports and imports.
  - New Zealand: only outflows exhibit a common stochastic trend with the current account balance and its underlying components.
  - Overall conclusion: strong long-run relationship between the current and financial account balances or their underlying components in a majority of cases.

### Main reduced-form results: determinants of cyclical fluctuations
- Current account balance:
  - Anticipated real output growth decreases the current account balance significantly in one country: Germany.
  - Unanticipated real output growth decreases the current account balance significantly in three countries: Denmark, France, and New Zealand.
  - Unanticipated real output growth increases the current account balance significantly in one country: Italy.
  - Bulk evidence: current account moves counter-cyclically with economic growth, and the relationship is mostly transitory.
  - No evidence of a significant effect of price inflation or the real exchange rate on the current account balance in any country in the sample; relative competitiveness via exchange rate or domestic inflation does not appear to be an important determinant in these industrial countries.
- Financial account and components:
  - Higher domestic growth is associated with improvements in the financial balance (financial inflows) in principle, as better investment opportunities attract inflows; however, empirical specifics for each country are reported in the paper's Tables 2 through 10 (tables not reproduced here).
  - REER movements and energy price changes have ambiguous effects on the financial balance: appreciation can signal strength and attract inflows, but can also reduce net inflows via currency valuation effects; higher energy prices may increase inflows from oil-producing countries.
- Relation between current and financial accounts in cyclical episodes:
  - Evidence indicates that fluctuations induced by domestic growth are a major joint source of movement in the current and financial balances: during a boom, domestic absorption exceeds GNI leading to a current account deficit, and concurrently higher growth stimulates financial inflows improving the financial account.
  - A current account deficit driven by high domestic growth is less worrisome if external funds are used for investment that yields returns exceeding required returns to international investors.
  - Conversely, current account deterioration driven by factors such as fiscal deficits may be more problematic because a twin-deficit scenario does not ensure the country can generate sufficient funds through growth to repay external debt.

### Policy-relevant implications and interpretation
- Cyclical origin matters:
  - Current account deficits associated with domestic growth booms tend to be financed by contemporaneous financial inflows and are less concerning when funds finance productive investment.
  - Deficits associated with fiscal deterioration or non-growth fundamentals are potentially more problematic for sustainability.
- Competitiveness variables (REER, inflation) did not show significant direct effects on current accounts across the sample, suggesting that standard competitiveness channels may be less decisive for short-term cyclicality in these industrial countries during the sample period.
- Long-run co-movement:
  - Cointegration evidence in most countries underscores the need to consider both current and financial accounts jointly when assessing external sustainability and the dynamics of external imbalances.

*Source: IMF Working Paper — chapter "11. Correlation Between Changes in the Current and Financial Balances and Underlying Components" (content unit provided).*

### Appendix I).

### _wp0556 - Appendix I)

### Determinants of fluctuations in the current account balance
- Energy price increases the current account balance significantly in two countries: Australia and Canada.
- Growth in the United States improves the current account balance significantly in one country: France.
- Growth in the euro area worsens the current account balance significantly in one country: Italy.
- Overall conclusion: evidence indicates the unsystematic (random) nature of fluctuations in the current account balance. Among variables considered, fluctuations in real output growth appear relatively more important to the cyclicality of the current account balance.

### Determinants of fluctuations in export growth
- Anticipated growth increases exports significantly in two countries: New Zealand and the United Kingdom.
- Unanticipated growth increases exports significantly in two countries: New Zealand and Sweden.
- Price inflation increases export growth significantly in seven countries: Canada, Denmark, France, Italy, New Zealand, Sweden and the United Kingdom.
  - Interpretation in text: "This indicates that the scale factor is stronger than the relative price channel."
- Energy price increases export growth in four countries: Denmark, New Zealand, Sweden, and the United Kingdom.
  - Interpretation: "This result indicates that oil-producing countries constitute a major share of the export market for many of the countries under investigation."
- Real exchange rate appreciation (Dreer) decreases export growth significantly in six countries: Australia, Canada, Denmark, France, New Zealand, Sweden, and the United Kingdom.
  - Interpretation: "Consistent with theory’s prediction, a real currency appreciation decreases export competitiveness and, therefore, decreases export growth."
- Growth in the United States stimulates export growth in one country: Sweden.
- Growth in major trading partners does not affect export growth significantly in any country.
- Synthesised finding: export growth in many industrial countries is highly dependent on domestic conditions and relative competitiveness; it is less dependent on global or regional conditions.

### Determinants of fluctuations in import growth
- Anticipated growth increases imports significantly in two countries: Australia and the United Kingdom.
- Unanticipated growth increases imports significantly in four countries: Australia, Denmark, New Zealand, and Sweden.
  - Text: "While real growth stimulates demand for imports, the relationship is mostly cyclical."
- Domestic price inflation increases imports significantly in four countries: Canada, France, Italy and New Zealand.
  - Mechanism: higher domestic price inflation increases the cost of non-tradables and therefore demand for imports.
- Energy price increases imports significantly in five countries: France, Germany, Italy, New Zealand, and the United Kingdom.
  - Interpretation: "indicating high dependency of industrial countries on energy imports."
- No evidence that currency appreciation increases imports. Instead, currency depreciation increases imports in six countries (consistent with a J-curve effect): Canada, Denmark, France, Italy, New Zealand, and Sweden.
  - Text: "That is, the price effect dominates the quantity effect on imports following a change in the exchange rate."
- United States growth increases imports significantly in one country: Canada.
- Overall conclusion: imports are highly dependent on domestic growth and price inflation. Under a flexible exchange rate regime, short-run exchange rate fluctuations are not effective to induce necessary changes in imports. Global and regional conditions have minimal effects on import growth.

### Determinants of fluctuations in the financial balance
- Anticipated growth does not determine the financial balance significantly in any country except Germany.
- Financial balance improves significantly with unanticipated growth in two countries: Denmark and France.
- No evidence of a significant effect of domestic inflation on the financial balance in any country.
- Energy price has a statistically significant negative effect on the financial balance only in Australia.
- No evidence of significant variation in the financial balance with the real exchange rate in any country except Sweden.
- No evidence that United States growth significantly affects the financial balance in any country.
- Growth in the euro area improves the financial balance significantly in one country: Sweden.
- Overall conclusion: the randomness of the financial balance does not appear to be well explained by cyclical fluctuations in domestic and external variables included in the model.

### Determinants of financial inflows
- Anticipated growth does not determine financial inflows significantly in any country.
- Unanticipated growth increases financial inflows significantly in one country: Australia.
- Price inflation significantly increases financial inflows in one country: Italy.
- No evidence that higher energy prices increase financial inflows in any country.
- Financial inflows decrease significantly with currency appreciation in one country: New Zealand.
  - Mechanism: appreciation decreases the value of foreign assets and return on foreign investment.
- UNITED STATES growth is consistent with a significant reduction in financial inflows in one country: Australia, and with a significant increase in another country: Italy.
- Growth in major trading partners does not determine financial inflows significantly in any country.
- Overall conclusion: high level of randomness surrounds financial inflows into industrial countries; this randomness is not fully explained by cyclical fluctuations in domestic and foreign variables in the model.

### Determinants of financial outflows
- Anticipated growth decreases financial outflows significantly in one country: Canada.
- A positive shock to output decreases financial outflows significantly in one country: Germany.
- Price inflation is consistent with a significant increase in financial outflows in one country: Italy.
- Energy price does not determine financial outflows significantly in any country.
- Financial outflow does not vary significantly with the currency value relative to major trading partners.
- United States growth increases financial outflow in two countries: Canada and Italy.
  - Interpretation: prospects of growth in the United States attract financial investors from these countries.
- Growth in major trading partners does not determine financial outflows significantly in any country.
- Overall conclusion: high degree of randomness associated with financial outflows; cyclical fluctuations in explanatory variables do not explain much of this randomness.

### Correlation between financial and current accounts
- Time-series correlations (Table 11) between the change in current and financial accounts:
  - Correlation coefficients between changes in current and financial balances are negative and significant for all countries, ranging from -0.39 in Denmark to -0.96 in Australia (column (1) summary).
  - Specific country value: Australia correlation = -0.96* (probability of zero correlation reported as (0.0001) in Table 11).
  - Combined (all countries) correlation between responses to various shifts within countries equals -0.85 (Table 12.A).
- Correlations between current account and its components:
  - Current account change correlates positively and significantly with export growth in two countries: Australia and Sweden.
  - Current account change correlates negatively and significantly with imports in three countries: France, Germany, and New Zealand.
- Correlations between financial balance and its components:
  - Financial inflows correlate positively with the financial balance, significant in two countries: Canada and New Zealand.
  - Financial outflows correlate negatively and significantly with the financial balance in one country: Australia.
- Correlations between estimated parameter responses across countries (Table 12.B):
  - Domestic expected growth (EDy): correlation coefficient -0.97 (Probability of Zero Correlation (0.0001)).
  - Domestic unanticipated growth (Dys): coefficient -0.88 (Probability (0.002)).
  - Price inflation (Dp): coefficient -0.31 (Probability (0.41)).
  - Energy price (Denergy): coefficient -0.30 (Probability (0.43)).
  - Real exchange rate (Dreer): coefficient -0.48 (Probability (0.18)).
  - DyUS (United States growth): coefficient -0.0015 (Probability (0.99)).
  - DyMT (growth in major trading partners): coefficient -0.87 (Probability (0.0049)).
- Interpretation: domestic growth (anticipated and unanticipated) is a major determinant of the negative correlation between current and financial accounts; higher domestic growth correlates with a larger current account deficit and an improved financial balance (i.e., negative correlation).

### Summary and conclusions (key findings and policy-relevant implications)
- Purpose and empirical setup:
  - The paper assesses cyclical sensitivity of key balance of payments components in nine industrial countries.
  - The empirical model relates components to: real GDP growth (expected and unexpected), inflation rate, real effective exchange rate, change in energy price, real growth in the United States (proxy for global growth), and real growth in major trading partners.
  - Cointegration tests and short-term reduced-form equations are used; expected vs unexpected growth separated via forecasts.
- Main empirical conclusions:
  - Cointegration tests confirm long-term relationships between the current and financial balances or their underlying components.
  - Correlation coefficient between current and financial accounts is negative; the ability to sustain a significant current account deficit depends on accumulating net financial flows.
  - Real growth raises imports and therefore negatively impacts the current account.
  - No evidence that higher inflation adversely affects the current account; inflation appears positively associated with both exports and imports in sample countries.
  - For oil-importing countries, higher energy prices increase import values; exports also increase in some countries in response to higher energy prices (possibly due to higher demand from oil-exporting countries).
  - Real currency appreciation reduces export growth (confirmed) but the positive relationship between imports and real exchange rate is not shown (possible J-curve dynamics).
  - Global or regional growth conditions do not have robust effects on import or export growth in the countries sampled.
  - Financial account cyclical behavior is harder to predict; model shows high randomness and limited explanatory power of included domestic and external variables.
  - Reduced-form regressions indicate cyclical factors have a stronger effect on short-term fluctuations in the current account than in the financial account.
  - Domestic growth is the most important factor explaining current and financial balances and their negative correlations over time.
- Policy-relevant implications:
  - The necessary and sufficient condition to sustain a large current account deficit is high growth that stimulates financial inflows and provides adequate resources for financing.
  - In the absence of high growth, sharp exchange rate movements (market-induced or policy-induced) may be necessary to correct widening current account deficits and achieve sustainable external balances.

### Key statistics and reported numeric magnitudes (selected)
- Country correlations between changes in current and financial balances:
  - Australia: -0.96* (probability (0.0001))
  - Canada: -0.86* (probability (0.0001))
  - Denmark: -0.39* (probability (0.043))
  - France: -0.84* (probability (0.0001))
  - Germany: -0.85* (probability (0.0001))
  - Italy: -0.61* (probability (0.0006))
  - New Zealand: -0.45* (probability (0.027))
  - Sweden: -0.49* (probability (0.010))
  - United Kingdom: -0.58* (probability (0.0016))
- Aggregate correlation across responses to various shifts within countries: -0.85 (Table 12.A, probability (0.0001)).
- Cross-country correlations between responses to specific shifts (Table 12.B):
  - EDy: -0.97 (probability (0.0001))
  - Dys: -0.88 (probability (0.002))
  - DyMT: -0.87 (probability (0.0049))
  - Dreer: -0.48 (probability (0.18))
  - Dp: -0.31 (probability (0.41))
  - Denergy: -0.30 (probability (0.43))
  - DyUS: -0.0015 (probability (0.99))

### Econometric methodology (appendix highlights)
- Expected growth constructed by regressing first difference of log real GDP on a constant, two lags of its own, two lags of first-difference of log GDP deflator, energy price, real effective exchange rate, and government expenditure; model reduction keeps variables significant at least at the 10 level. Shocks equal actual minus forecast.
- Expectation equations are jointly estimated with the rest of the model using 3SLS; instrument list includes two lags of first-differences of representative short-term interest rate, log real GDP, GDP deflator, energy price, real effective exchange rate, DyUS, DyMT, money supply, and government spending.
- Serial correlation addressed by filtering the empirical models with (1 − Lρ), where ρ is the serial correlation parameter; reported estimates are after transformation to eliminate serial correlation.

*Italicized source: Appendix I of _wp0556 (IMF Working Paper PDF)._

### REFERENCES

### REFERENCES

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- Muller-Plantenberg, Nikolas, 2003, “Current Account Reversals Triggered by Large Exchange Rate Movements," (Unpublished Manuscript, London: London School of Economics).  
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### Citations on Exchange Rates, Real Exchange Rate Fluctuations, and Trade
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- Krugman, Paul, 1989, “Differences in Income Elasticities and Trends in Relative Exchange Rates," European Economic Review, Vol. 33, No. 5, pp. 1031–54.  
- Lane, Philip, 1999, “Money Shocks and the Current Account," (Unpublished Manuscript: Dublin, Trinity College).  
- Prasad, Eswar. S., 1999, “International Trade and the Business Cycle," Economic Journal, Vol. 109, No. 458, pp. 588–606.  

### Citations on Macroeconomic Fluctuations, Business Cycle Models, and Nominal Sticky Prices
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### Citations on Econometric Methods, Cointegration, Unit Roots, and Diagnostics
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### Other Empirical and Theoretical Contributions
- Billmeier, Andreas, 2002, “Current Account Fluctuations: How Important are Nominal Shocks?" (Unpublished Manuscript, Florence: European University Institute).  
- Cooper, Richard N., 2001, “Is the United States Current Account: Deficit Sustainable? Will It Be Sustained?" Brookings Papers on Economic Activity, No. 1, pp. 217–26.  
- Fayan, Gabriel, Jerome Henry, and Ricardo Mestre, 2001, “An Area Wide Model (AWM) for the Euro Area, ECB Working Paper No. 42 (Frankfurt: European Central Bank).  
- Kandil, Magda, and Joshua Greene, 2002, “The Impact of Cyclical Factors on the United States Balance of Payments," IMF Working Paper No. 02/45 (Washington: International Monetary Fund).  
- Krugman, Paul, 1989, “Differences in Income Elasticities and Trends in Relative Exchange Rates," European Economic Review, Vol. 33, No. 5, pp. 1031–54.  
- Muller-Plantenberg, Nikolas, 2003, “Current Account Reversals Triggered by Large Exchange Rate Movements," (Unpublished Manuscript, London: London School of Economics).  
- Milesi-Ferretti, Gian Maria and Assaf Razin, 1996, “Current Account Sustainability," Princeton Studies in International Finance No. 81 (Princeton, N. J. :International Finance Section, Princeton University).  

*Reference list as provided in the content unit*

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