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When Do Long‐term Imbalances Lead to Current Account Reversals?
Author(s) -
Benhima Kenza,
Havrylchyk Olena
Publication year - 2010
Publication title -
world economy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.594
H-Index - 68
eISSN - 1467-9701
pISSN - 0378-5920
DOI - 10.1111/j.1467-9701.2009.01206.x
Subject(s) - net foreign assets , current account , economics , term (time) , global imbalances , asset (computer security) , explanatory power , econometrics , sample (material) , predictive power , measure (data warehouse) , monetary economics , exchange rate , computer science , philosophy , chemistry , physics , computer security , epistemology , chromatography , quantum mechanics , database
We extend the literature on sharp reductions in current account deficits by taking into account not only short‐term determinants, but also the deviation of net foreign assets from their long‐run equilibrium level. First, we analyse the long‐term relationship between net foreign assets and a set of explanatory variables and construct a measure of imbalances. Next, we model current account reversals by incorporating this new measure and compare the predictive power of this model with the baseline specification that does not account for long‐term imbalances. Our new model has a superior performance in and out‐of‐sample, especially when we control for the sign of imbalances. We also find that low net foreign assets do not necessarily lead to sharp reductions in current account deficits; it is rather the situation when they are below their equilibrium level that triggers reversals. Finally, we document that our new measure of net foreign asset imbalances is important only for developing countries, whereas standard models perform well for industrial economies.