Abstract
The aim of this paper is to study the main macroeconomic, financial and structural factors that shaped current account developments in Greece over the period from 1960 to 2007 and discuss these developments in relation to the issue of external sustainability. Concerns over Greece’s external sustainability have emerged since 1999 when the current account deficit widened substantially and exhibited high persistence. The empirical model used, which theoretically rests on the intertemporal approach, treats the current account as the gap between domestic saving and investment. We examine the behaviour of the current account in the long run and the short run using co-integration analysis and a variety of econometric tests to account for the effect of significant structural changes in the period under review. We find that a stable equilibrium current account model can be derived if the ratio of private sector financing to GDP, as a proxy for financial liberalisation, is included in the specification. Policy options to restore the country’s external sustainability are explored based on the estimated equilibrium model.
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Notes
See Debelle and Faruqee (1996), Faruqee and Debelle (1998) and Chinn and Prasad (2003). A less developed country has a larger deficit, as the marked need for investment is accompanied by relatively low domestic saving. At an early stage of development, the external financing requirement initially rises with the increasing development of a country, but then goes down when a higher level of development has been achieved.
About one-fifth of the decline of the ratio of private saving to GDP can be attributed to the fall in the disposable income to GDP ratio, reflecting increased taxation of the private sector.
On the other hand, an anticipated permanent change in national cash flow, say due to an increase in output, will cause a one-for-one change in consumption leaving the current account unaltered (Makrydakis 1999).
For a literature review, see Debelle and Faruqee (1996), Bussière et al. (2005) and Briotti (2005). The empirical work by Nickell and Vansteenkiste (2008) shows that the government debt to GDP ratio can partly explain the Ricardian or Keynesian behaviour of private agents. In countries with debt to GDP ratios up to 90%, the relationship between the government balance and the current account balance is positive, i.e. an increase in the fiscal deficit leads to a higher current account deficit. In very high debt countries, however, this relationship turns negative but insignificant, implying that a rise in the fiscal deficit does not result in a rise in the current account deficit. Implicitly, this result suggests that households in very high debt countries tend to become Ricardian. The composition of government spending may also be important (see Bayoumi and Masson 1998). For example, public investment, to the extent that it is viewed as productive, is not expected to require further taxes and should not generate a private saving response. By contrast, investment that does not generate revenues for the government (and is considered equivalent to government consumption) would involve future taxes and might induce a larger private saving offset.
The income effect of interest rate changes on saving is not taken into account, as most empirical studies have found a positive, although often insignificant, interest rate elasticity of saving.
See also Herrmann and Jochem (2005).
For a discussion see Coakley et al. (1996).
Net payments of interest and net receipts from shipping largely account for the net factor income component of the Greek current account.
In order to test for co-integration between the two variables, the Engle-Granger approach is used. Since over longer periods shifts in industrial structure, productivity, etc. may have occurred which altered the long-run relationship, the Gregory and Hansen (1996) co-integration tests that account for an endogenously determined break are applied. This is a two-step procedure (as is also the Engle-Granger procedure), in which dummy variables are included in the co-integrating equation to account for possible shifts.
The results do not include variables that were found insignificant in the co-integration analysis (see also footnote 17).
The results of the PP and the KPSS unit root tests are available from the authors upon request.
Since this result might be biased in favour of accepting the null hypothesis of no co-integration, due to the existence of structural breaks, the Gregory-Hansen test which accounts endogenously for possible changes in the co-integration vector over the estimation period was applied. The various tests (level shift: −4.02, level shift with trend: −4.25 and regime shift with potential break point: −4.55) suggested that the data support the hypothesis of no co-integration between the two variables.
Preliminary estimations of the model showed that the real interest rate (RIR) and the demographic variables (DEM) were not significant and therefore these variables were omitted. All the regressions are available from the authors upon request.
A one year lag for all the variables of the error correction model was adopted.
All the linearity tests strongly reject the null hypothesis of linear relationship for both models (LR = 24.32 and LR = 42.95, respectively). Moreover, the AIC and SC criteria are smaller in value in the case of non-linear models indicating a better fit. In addition, standard errors are different among regimes in both models, but considerably smaller compared with that of the linear model. This last finding suggests that the correlation among the variables is different across regimes.
We deemed this approach more appropriate, because a current account “norm” estimated using a long-term (equilibrium) relationship may not necessarily be identical to the notion of a “sustainable” current account; in practice, such norm could also be derived from values of the current account determinants that imply external debt non-sustainability. Thus, this norm should not be adopted as a current account benchmark for adjustment, but instead the current account that stabilises the net foreign asset position should be used.
A recent study by Brissimis and Vlassopoulos (2009) shows that mortgage loans have a unitary long-run elasticity with respect to GDP.
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Brissimis, S.N., Hondroyiannis, G., Papazoglou, C. et al. Current account determinants and external sustainability in periods of structural change. Econ Change Restruct 45, 71–95 (2012). https://doi.org/10.1007/s10644-011-9107-y
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DOI: https://doi.org/10.1007/s10644-011-9107-y