DISSERTATION PAPER

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DISSERTATION PAPER

• Current Account and its Determinants
• in Central and Eastern Europe
• Student Monica Tanu
• Professor Moisa Altar

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Objective

• to provide an empirical investigation of the
  medium-term determinants of current account for a
  sample of Central and East European countries
• are used cross-section and panel regression
  techniques
• my approach iews current account as the outcome
  of variations in structural and macroeconomic
  determinants that influence the saving-investment
  balance
• the data set covers a heterogeneous group of
  Central and East European countries over a
  relative medium time span (1990 - 1999).

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Review of the literature

• intertemporal approach to current account -
  private saving and investment decisions result
  from forward-looking calculation based on
  expectations
• the current account balance behaves as a buffer
  against transitory shocks in productivity and
  demand
• shocks may be
• country-specific or global (origin)
• transitory or permanent (persistence)
• I take into account how the nature of economic
  changes impact on the current account -
• overtime changes within a country
• the evolution of the world economy
• structural differences across countries

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Savings, Investment and the Current Account

• GNP t Y t r t B t
• Y t C t G t I t NX t
• CA t NX t r t B t GNP t ( C t G t I t)
• CA t S t - I t
• CA t ( B t1 K t1 B t K t ) I t B
  t1 B t

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Savings, Investment and the Current Account

• viewing the current account as net exports or as
  the difference between savings and investment is
  equivalent from an accounting perspective
• movements in interest rate, exchange rates,
  prices and income will ensure that the decision
  to export and import and to save and to invest,
  made at microeconomic level will match in the
  aggregate
• defining the current account as the difference
  between savings and investment is more
  appropriate when trying to explain enduring
  patterns in international capital flow.

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Current account sustainability

• the current account balance is an important and
  intriguing measure of macroeconomic performance
  for economies in transition
• it is often difficult to distinguish between
  current account deficits that are the consequence
  of growth inducing capital inflows and current
  account deficits that result in debt accumulation
  that cannot be sustained
• most of transition economies experienced large
  current account deficits due to decline in output
  and financing by official international
  assistance and borrowing.

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Criteria for assessing sustainability

• a non-increasing foreign debt to GDP ratio
• the countrys willingness to pay and the
  creditors willingness to lend
• no external sector crises occurs (in a situation
  where current macroeconomic conditions continue
  and are no changes in macroeconomic policy)
• exchange rate crises
• foreign debt crises
• close attention should be paid to any current
  account deficit in excess of 5 of GDP,
  particularly if it is financed in a way that
  could lead to rapid reversals (Lawrence Summers)

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Sources of current account deficit

• a fall in savings or an increase in investment
• running a current account deficit involves
  borrowing from abroad which is less dangerous if
  it is financing new investment rather than
  consumption
• large current account deficits may be more
  sustainable if economic growth is higher
• a current account imbalance can be due to a fall
  in
• private savings
• public savings (higher budget deficits)

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CA in economic policymaking

• the essence of the policymakers problem is to
  determine a sustainable set of economic policies
• reasonable economic growth performance
• price stability
• a sustainable fiscal position
• low unemployment
• a sustainable current account position

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CA in economic policymaking
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Econometric methodology

• I use an panel of 140 annual observations from 5
  Central and East European countries
• main sources are World Bank - World Development
  Indicators 2001 - and IMF- International
  Financial Statistics
• I work with time series and cross-country data
• I identify and differentiate within-country and
  cross-country effects
• the model considers inertial properties in the
  current account deficit by allowing for an
  independent effect from its lagged value

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Econometric methodology

• 1. Cross-country effects
• country-specific factors are not controlled for
• y i t ß 1 y i t-1 ß 2 X i t e i t
• 2. Within-country effects
• this model allow me to de-emphasize the
  cross-sectional variance in favor of its
  time-series counterpart
• akin to the fixed-effects estimator
• y i t ß 1 y i t-1 ß 2 X i t ? i e i t

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Econometric methodology

• Methods of estimation
• Seemingly Unrelated Regression
• residuals are cross-section heteroskedastic
• residuals are contemporaneously correlated
• Cross section weights
• residuals are cross-section heteroskedastic
• Pooled least squares

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Exogenous variables

• Persistence
• CA lagged 1 period
• Internal Condition
• Domestic Output Growth Rate (annual )
• Savings (as of GDP)
• Investment (as of GDP)
• Financial Deepening (M2/GDP)
• External Condition
• Openess (as of GDP)
• Net Foreign Assets (as of GDP)
• Real Effective Exchange Rate (in logs)

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Exogenous variables

• Evolution of the World Economy
• Industrialized Output Growth Rate (annual )
• World Real Interest Rate
• Additional Financial Variables
• Youth dependency ratio
• Old dependency ratio
• Foreign Direct Investment (as of GDP)
• Relative GDP per capita
• External debt (as of GDP)

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Cross-country effects

• Persistence
• the coefficient is positive and significant
  (0.27)
• moderate persistence of transitory shocks
• Domestic output growth rate
• the coefficient is negative and significant
  (-0.12)
• GDP implications on savings and investment

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Cross-country effects

• Savings and Investment
• both have significant coefficient across all
  considered estimators ( 0.74 and -0.57)
• Financial Deepening
• a potentially important determinant of savings
• proxied by the ratio of M2 to GDP
• a positive effect on the current account, but it
  is not significant (0.007)

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Cross-country effects

• Openness
• the degree of openness - make a country
  attractive to foreign capital
• more open economies generate foreign exchange
  earnings through exports - a better ability to
  service external debt
• negative relationship with the current account
  (-0.008)
• Net Foreign Assets
• countries that have run current account deficits
  - countries with better access to capital markets
  - are favored by international investors for a
  variety of reasons
• negative relationship (-0.03)

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Cross-country effects

• Real Effective Exchange Rate
• significant positive relationship (-0.015)
• I study the delayed effects of REER on the
  current account
• the net effect (adding the coefficients on
  contemporaneous and lagged REER) is similar to
  the coefficient of the REER in the core
  specification

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Cross-country effects

• Output Growth Rate of Industrialized Country
• positive and significant coefficient (1.17)
• an increase in growth rate -gta rise in the demand
  for the exports and increase capital flow
  between industrialized countries
• International Real Interest Rate
• positive coefficient (0.15)
• net debtor countries widen their demand for intl
  capital in response to interest rate reductions.

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Cross-country effects

• Age dependency ratio
• positive coefficient (0.16 - Youth, 0.22 - Old)
• national savings is not the channel through which
  dependency ratio affect current account
  positions.
• Foreign Direct Investment
• negative and significant coefficient (-0.06)
• higher rates of capital accumulation and growth
• facilitate the transfer of managerial and
  technological knowhow

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Cross-country effects

• Relative GDP per capita
• negative and significant coefficient (-0.03)
• doesnt sustained the stage of development
  hypothesis
• External debt
• positive coefficient (0.01)
• countries with larger external debt tend to have
  smaller current account deficits because of rhe
  external financing constraints.

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