WELLCOME

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WELLCOME
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• Determinants of current account deficits in
  Central and East European Countries
• Stylized Facts

Mihai Antonio Ciobanu
The views expressed in this Dissertation Paper
are those of the author and do not necessarily
represent those of the DOFIN or ASE Bucharest.
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Determinants of current account deficits

• Objective
• To examine the empirical linkage between current
  account deficits and a broad set of economic
  variables proposed by the theoretical and
  empirical literature for a panel of CEE countries.

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Determinants of current account deficits

• Abstract
• This paper provides an empirical investigation of
  the determinants of current account deficits for
  a sample of CEE countries.
• The analysis is based on a reduced form approach
  that highlights the roles of the fundamental
  macroeconomic determinants of current account
  deficits.
• Within-country and cross-country regression
  techniques are used to characterize the
  properties of current account deficits across
  countries and over time.
• I use a heterogeneous group of 5 CEE countries
  over a relative medium time period (1990 1998).

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Determinants of current account deficits

• Contents
• The first section contains a discussion of some
  theoretical models germane to the empirical
  modeling of current account deficits.
• The second section presents the empirical results
  from regressions.
• The final section emphasize the concluding
  remarks.

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Review of the literature

• Introduction
• Economic theory provide some conceptual tools for
  analyzing a countrys current account position,
  as well as some useful insights about the
  behavior of its current account balance in
  response to shifts in the stance of economic
  policies or other autonomous shocks.
• The models, that I will present shortly,
  progressively shifts the emphasis in analyzing
  the current account from trading relationships to
  financial variables and the role of capital
  markets, reflecting the changes in the
  determinants of international transactions in the
  last two decades.

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Review of the literature

• The Mundell Fleming Analysis
• It describes simple adjustment mechanism in a
  model of stationary flow equilibrium and static
  exchange rate expectations.
• The model determines the combinations of real
  interest rate and real output at which markets
  for goods, money and foreign exchange are in
  equilibrium.
• It neglects the impacts of net investment on the
  capital stock and of current account deficits on
  the net international indebtedness.
• Do not describe the longer-run path that result
  from the interaction of stocks and flows.

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Review of the literature

• The Savings-Investment Gap
• CAt Spt Sgt Igt Ipt
• In countries where the opportunities for
  investment in productive capital have been
  sizeable relative to saving propensities, current
  account deficits might be sustainable for longer
  period of time.
• Ricardian equivalence (Barro 1974).
• Since an expansionary fiscal policy represents a
  decrease in government savings, it might induce a
  compensating increase in private savings, as
  individuals may lower their current consumption
  to pay higher future taxes.

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Review of the literature

• The Consumption-Smoothing Approach
• Focuses on the long-run saving and investment
  decision of private agents.
• The intertemporal sustainability of current
  account.
• What determines the current account position of a
  particular country is the saving-investment gap,
  which ultimately depends on the willingness of
  foreigners to hold their liabilities.
• The net present value of investment project
  should be positive, whereas the geographical
  source of financing is irrelevant (a sort of
  Modigliani-Miller Irrelevance Theorem of
  international macroeconomics).

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Review of the literature

• The Consumption-Smoothing Approach
• The current account balance is influenced by two
  factors
• the deviations of the key variable from their
  permanent levels and
• the discrepancy between the world market discount
  rate and the residents impatience relative to
  the interest rate.
• (Obstfeld and Rogoff 1996).

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Review of the literature

• Overlapping Generations Models
• The preceding approach suppose that the labor
  force is homogenous, neglecting life-cycle
  considerations.
• Diamond , Peter 1965 National Debt in a
  Neoclassical Growth Model.
• When population growth rate increases the savings
  rate goes up because the number of the younger
  people (savers) rises relative to that of elder
  people (dissavers). As a consequences, the
  current account will reflect the age composition
  of the population and the participation in the
  workforce.

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Review of the literature

• Capital Flows and Uncertainty
• Obstfeld and Rogoff 1996 Foundations of
  International Macroeconomics.
• Current account deficits are not undesirable, but
  in order to attract and enjoy the benefits of
  foreign financing, a country must maintain a
  steady and appropriate stance of both fiscal and
  monetary policy, and must improve the functioning
  and transparency of its markets.

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Review of the literature

• The Current Account in Economic Policymaking
• The essence of policymaking is to determine a set
  of policies that will yield
• Reasonable economic growth performance
• Price stability
• A sustainable fiscal position
• Low unemployment
• A sustainable current account position (the
  societys choices about savings and investment
  balances are consistent with the amount of
  financing that the rest of the world is prepared
  to lend or to borrow at prevailing interest and
  exchange rates).

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Review of the literature

• The Current Account in Economic Policymaking
• The challenge of determining the aspects on which
  the policymakers need to concentrate in each
  particular case.
• What paradigm is most appropriate to the specific
  circumstances of the country?
• The broad spectrum of options that should guide
  their decisions.

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The empirical framework

• Data
• I use an unbalanced panel of 153 annual
  observation from 5 CEE countries over the period
  1990 1998.
• Detailed definition and sources are presented in
  the Appendix.
• The main sources are World Bank World
  Development Indicators and IMF International
  Financial Statistics.

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The empirical framework

• Econometric Methodology
• Time-series and cross-country data.
• Within-country and cross-country effects.
• Inertial properties in the current account
  deficits.
• All explanatory variables are assumed to be
  exogenous.

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The empirical framework

• Econometric Methodology
• Pooled Least Squares method
• No heteroskedasticity.
• No contemporaneous correlation.
• GLS (Cross Section Weights) method
• No contemporaneous correlation.
• Seemingly Unrelated Regression method
• My preferred method of estimation.

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The empirical framework

• The dependent variable
• Current account deficit as ratio to GDP
• The independent variable
• The lagged current account deficit
• The domestic output growth rate
• Private and public savings ratios with respect to
  GDP
• The share of exports in GDP
• The real effective exchange rate
• The terms of trade
• The output growth rate of industrialized
  countries
• The international real interest rate

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The empirical framework

• Within-country effects
• Regression on yearly data.
• Fixed-effects estimator method.
• It emphasize the current account response to
  over-time changes in a given country.
• De-emphasize the cross-sectional variation of the
  data in favor of its time-series counterpart.
• yit ?i yit-1ß Xitßm e

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The empirical framework

• Within-country effects
• Persistence
• The lagged current account deficits
• 0.22 moderate persistence of transitory shock.
• Controlling for country-specific factors, the
  current account deficit is stationary (Ghosh and
  Ostry 1995)
• Statistical significant estimator

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The empirical framework

• Within- country effects
• Public and private saving
• - 0.58 public saving - 0.20 private
  saving
• It appears that shocks in private saving rate are
  accompanied almost one-to-one by investment rate
  shocks.
• Private savings provide a significant but not
  complete Ricardian offset to changes in public
  saving.
• Government budget deficits tend to induce current
  account deficits by redistributing income from
  future to present.
• The twin deficit discussion of the 1980.
• Statistically significant estimators.

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The empirical framework

• Within-country effects
• Domestic Output Growth
• 0.22
• Although a rise in growth may be associated with
  an increase in saving rate, it seems that its
  correlation with the investment rate is somewhat
  larger, thus leading to a worsening of the
  current account deficit.
• Statistically significant estimator.

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The empirical framework

• Within-country effects
• Exports
• -0.08
• The transmission mechanism is most likely through
  the trade balance.
• Statistically significant estimator.

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The empirical framework

• Within-country effects
• Real effective exchange rate
• 0.04 consistent with the prediction of the
  Mundell-Fleming model.
• A depreciation of the exchange rate has the
  effect of reducing the current account deficit.
• 0.03 REER current year 0.03 REER lagged one
  year
• No evidence in support for the J-curve
  hypothesis.
• Statistically significant estimators.

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The empirical framework

• Within-country effects
• Terms of trade
• -0.04 consistent with Harberger-Laursen-Metzler
  effect.
• Adverse transitory terms of trade shocks produce
  a decline in current income that is greater than
  in permanent income. Hence, a decline in savings
  follows and, thus, a deterioration in the CA
  position ensues.
• Statistically significant estimator.

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The empirical framework

• Within-country effects
• Output growth rate of industrialized countries
• -0.21
• Rise in the demand for the exports of developing
  countries and increased capital flows between
  industrialized countries at the expense of flows
  to developed countries.
• Statistically significant estimator.

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The empirical framework

• Within-country effects
• International real interest rate
• -0.34
• Net debtor countries widen their demand for
  international capital in response to interest
  rate reduction.
• Lower interest rates induce international
  investors to look for investment opportunities in
  CEE countries.
• Statistically significant estimator.

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The empirical framework

• Within-country effects
• External indebtedness
• 0.13
• The transmission mechanism is likely though the
  revenue balance.
• Statistically significant estimator.

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The empirical framework

• Within-country effects
• Stages of development hypothesis
• The size of current account deficit decreases as
  a country develops in relation to the rest.
• Relative per capita income the log of ratio of
  per capita GDP of CEE country to the per capita
  GDP of USA.
• 0.4 no support for the hypothesis
• Not statistically significant coefficient.

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The empirical framework

• Within-country effects
• The demographic profile of the population
• Age dependency ratio
• -2.25
• Demographic factors play a more important role in
  the current account variation than through the
  saving channel.

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The empirical framework

• Within-country effects
• Foreign direct investment
• 0.12 a positive correlation
• The likely mechanism is through the trade
  balance.
• No statistically significant estimator.

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The empirical framework

• Cross-country effects
• Regression on yearly data.
• Country specific factors are not controlled.
• Focus on trends.
• Show how the differences in current account
  deficits across countries are driven by their
  respective characteristics.
• yit yit-1ß Xitßm e

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The empirical framework

• Cross-country effects
• Persistence
• Empirical result A moderate positive degree of
  persistence
• Public and private saving
• Empirical result Countries with higher public
  and private saving present lower current account
  deficits.

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The empirical framework

• Cross-country effects
• Domestic output growth
• Theory The effects of GDP growth on saving
  behavior is not clear cut.
• Empirical result Countries with higher domestic
  growth rate have larger current account deficits.
• Exports
• Theory The capacity that more open economies
  have to generate foreign exchange earnings might
  signal a better ability to service external debt
  and make a country attractive to foreign capital.
• Empirical result Countries with larger exports
  (relative to GDP) present smaller current account
  deficit.

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The empirical framework

• Cross-country effects
• Real effective exchange rate
• Empirical result A positive correlation between
  real effective exchange rate and the current
  account deficit.
• Terms of trade
• An important determinant of short-term
  fluctuations in the current account balance.
• Influence the investment and saving behavior of
  the economic agents.
• Empirical result Higher terms of trade are
  associated with smaller current account deficits,
  consistent with the notion of this augmentation
  inducing more trade balance surpluses.

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The empirical framework

• Cross-country effects
• Output growth rate of industrialized countries
• Empirical result In periods when the
  industrialized output growth rate is larger, the
  current account deficit of CEE countries is
  reduced.
• International real interest rate
• Empirical result In periods when international
  real interest rate is higher, the current account
  deficit is reduced.

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The empirical framework

• Cross-country effects
• Stages of development hypothesis
• Theory The size of current account deficit
  decreases as a country develops in relation to
  the rest.
• Relative per capita income the log of ratio of
  per capita GDP of CEE country to the per capita
  GDP of USA.
• Empirical result Positive and significant effect
  of relative per capita GDP on the current account
  deficit, which gives no support to the stages of
  development hypothesis.

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The empirical framework

• Cross-country effects
• Demographic profile of the population
• Age dependency ratio
• Empirical result The estimated coefficient is
  consistently negative and statistically
  significant.
• Higher dependency ratios are associated with
  smaller current account deficits.
• Demographic variable affect a country propensity
  to run current account deficits beyond their
  effect through private saving.

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The empirical framework

• Cross-country effects
• Foreign direct investment
• Theory The increase in the foreign direct
  investment will lead to an increase in the
  current account deficit.
• Empirical result No statistically significant
  association between FDI and current account.
• External debt
• Empirical result Countries with larger external
  debt tend to have smaller current account
  deficits because of the external financing
  constraints.

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Concluding remarks

• There is a moderate level of persistence in the
  current account deficit beyond what can be
  explained by the behavior of its determinants.
• The domestic output growth rate has a positive
  impact on the current account deficit, indicating
  that the domestic growth rate is associated with
  a larger increase in the domestic investment than
  in national saving.

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Concluding remarks

• The growth rate of industrialized countries
  contributes to reduce the current account
  deficits of CEE countries.
• Changes in private and public saving rates
  contribute to an important decrease in the
  current account deficit.
• The increase in exports lowers the current
  account deficit, likely through a direct effect
  on the trade balance.

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Concluding remarks

• An appreciation of the real effective exchange
  rate generates an increase in the current account
  deficit.
• The terms of trade are positively correlated with
  the current account deficits in CEE countries.

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Concluding remarks

• Reductions in the international real interest
  rates generate an increase in current account
  deficits. This is consistent with an increased
  demand for foreign financing and a rise in the
  supply of foreign capital when international real
  interest rates are low.
• The stages of development hypothesis couldnt be
  validated by the empirical findings countries
  whose per capita GDP is closer to that of US do
  not tend to run lower current account deficits

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Concluding remarks

• The stylized facts presented in this paper have
  left a number of important questions unanswered,
  presenting a fertile agenda for future work
• the dynamic effects of shocks with different
  degree of persistence on the current account
  deficits, from an intertemporal perspective.
• the channels through which different shocks could
  affect variations in the current account deficits
  (for example, via the trade balance or other
  components of the current account).

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