The Current Account Income Balance: External Adjustment Channel or Vulnerability Amplifier?

IMF Working Papers, May 27, 2022

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Canonical URL: The Current Account Income Balance: External Adjustment Channel or Vulnerability Amplifier?

Paper examines the role of the net income balance (IB) in stabilizing or destabilizing the current account over the cycle and in crises.
Compares the size and behavior of the IB to the trade balance (TB) and assesses whether IB acts as an external adjustment channel or amplifies vulnerabilities.
Also estimates IB semi-elasticities with respect to the exchange rate (ER).

In terms of size, the IB is comparable to the TB for many countries.
Due to a negative correlation with the TB, the IB significantly dampens the time series volatility of the current account for most countries.
The IB generally does not improve during crisis episodes; therefore, current account adjustment during crises occurs entirely through improvements in the TB.
Estimated IB semi-elasticities with respect to the ER are small for most countries.
Because IB semi-elasticities are small, the IB is generally not a significant channel through which the ER stabilizes the current account.
Trade-based semi-elasticities are, with some important exceptions, good proxies for current account semi-elasticities used in external sector assessments.

Subject: Balance of payments, Credit, Current account, Exchange rates, Financial crises, Foreign exchange, Income, Money, National accounts
Keywords: B. estimation methodology, Credit, Crisis, Current account, current account adjustment, D. estimation procedure, Exchange rate elasticity, Exchange rates, Fixed-effects counterfactual estimators, Global, Global imbalances, Income, Income balance, Sudden stop