Skip to main content

Advertisement

Log in

Current account determinants and external sustainability in periods of structural change

  • Published:
Economic Change and Restructuring Aims and scope Submit manuscript

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.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2
Fig. 3

Similar content being viewed by others

Notes

  1. 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.

  2. 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.

  3. 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).

  4. 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.

  5. For further evidence showing that financial liberalisation increases consumption, and significantly decreases saving, while it does not substantially increase investment, see Melitz (1990), Englund (1990) and Osugi (1990).

  6. 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.

  7. See for example, Dayal-Gulati and Thimann (1997) and recent work by Nocetti and Smith (2010).

  8. See also Herrmann and Jochem (2005).

  9. For a discussion see Coakley et al. (1996).

  10. Net payments of interest and net receipts from shipping largely account for the net factor income component of the Greek current account.

  11. 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.

  12. Following Krolzig (1997) and Krolzig et al. (2002), the RS-R and the TA-R models are estimated with shifts in the coefficients (including the constant) and the error variance Σ.

  13. The RS-R and the TA-R models are estimated by means of the EM algorithm proposed by Dempsteir et al. (1977), using the MSVAR software developed by Krolzig. For more details, see Krolzig (1997).

  14. The results do not include variables that were found insignificant in the co-integration analysis (see also footnote 17).

  15. The results of the PP and the KPSS unit root tests are available from the authors upon request.

  16. 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.

  17. 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.

  18. A one year lag for all the variables of the error correction model was adopted.

  19. 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.

  20. 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.

  21. A recent study by Brissimis and Vlassopoulos (2009) shows that mortgage loans have a unitary long-run elasticity with respect to GDP.

References

  • Andrews DWK, Kim JY (2003) End-of-sample co-integration breakdown tests. Discussion Paper 1404, Cowles Foundation

  • Bayoumi TA (1993) Financial deregulation and consumption in the United Kingdom. Rev Econ Stat 75:536–539

    Article  Google Scholar 

  • Bayoumi TA, Masson PR (1998) Liability-creating versus non-liability-creating fiscal stabilisation policies: Ricardian equivalence, fiscal stabilisation and EMU. Econ J 108:1026–1045

    Article  Google Scholar 

  • Bergin PR, Sheffrin SM (2000) Interest rates, exchange rates and present value models of the current account. Econ J 110:535–558

    Article  Google Scholar 

  • Blanchard O, Giavazzi F (2002) Current account deficits in the euro area: the end of the Feldstein-Horioka puzzle? Brook Papers Econ Act 2:147–186

    Article  Google Scholar 

  • Briotti MG (2005) Economic reactions to public finance consolidation: a survey of the literature. ECB Occasional Paper 38, European Central Bank

  • Brissimis SN, Vlassopoulos T (2009) The interaction between mortgage financing and housing prices in Greece. J Real Estate Fin Econ 39:146–164

    Article  Google Scholar 

  • Buiter WH (1981) Time preference and international lending and borrowing in an overlapping-generations model. J Polit Econ 89:769–797

    Article  Google Scholar 

  • Bussière M, Fratzscher M, Müller GJ (2004) Current account dynamics in OECD and EU acceding countries—an intertemporal approach. ECB working paper 311

  • Bussière M, Fratzscher M, Müller GJ (2005) Productivity shocks, budget deficits and the current account. ECB working paper 509

  • Ca’ Zorzi M, Rubaszek M (2008) On the empirical evidence of the intertemporal current account model for the euro area countries. ECB working paper 895

  • Ca’ Zorzi M, Chudik A, Dieppe A (2009) Current account benchmarks for Central and Eastern Europe: a desperate search? ECB working paper 995

  • Chinn MD, Prasad ES (2003) Medium-term determinants of current accounts in industrial and developing countries: an empirical exploration. J Int Econ 59:47–76

    Article  Google Scholar 

  • Coakley J, Kulasi F, Smith R (1996) Current account solvency and the Feldstein-Horioka puzzle. Econ J 106:620–627

    Article  Google Scholar 

  • Dayal-Gulati A, Thimann C (1997) Saving in Southeast Asia and Latin America compared: searching for policy lessons. In Hicklin J et al. (eds) Macroeconomic issues facing ASEAN countries. International Monetary Fund, pp 130–150

  • Debelle G, Faruqee H (1996) What determines the current account? A cross-sectional and panel approach. IMF working paper 58

  • Dempsteir AP, Laird NM, Rubin DB (1977) Maximum likelihood from incomplete data via the EM algorithm. J R Stat Soc (Ser B) 39:1–38

    Google Scholar 

  • Dickey DA, Fuller WA (1979) Distributions of the estimators for autoregressive time series with a unit root. J Am Stat Assoc 74:427–431

    Article  Google Scholar 

  • Dickey DA, Fuller WA (1981) The likelihood ratio statistics for autoregressive time series with a unit root. Econometrica 49:1057–1072

    Article  Google Scholar 

  • Engle RF, Granger CWJ (1987) Co-integration and error correction: representation, estimation, and testing. Econometrica 55:251–276

    Article  Google Scholar 

  • Englund P (1990) Financial deregulation in Sweden. Eur Econ Rev 34:385–393

    Article  Google Scholar 

  • Faruqee H, Debelle G (1998) Saving-investment balances in industrial countries: an empirical investigation. In Isard P, Faruqee H (eds) Exchange rate assessment: extensions of the macroeconomic balance approach. IMF occasional paper 167. pp 35–55

  • Faulkner-Mac Donagh C, Mühleisen M (2004) Are US households living beyond their means? Fin Dev 41:36–39

    Google Scholar 

  • Freund CL (2000) Current account adjustment in industrialized countries. International finance discussion papers 692. Board of Governors of the Federal Reserve System

  • Gandolfo G (2001) International finance and open-economy macroeconomics. Springer, New York

    Book  Google Scholar 

  • Garganas NC, Tavlas GS (2001) Monetary regimes and inflation performance. In: Bryant RC, Garganas NC, Tavlas GS (eds) Greece’s economic performance and prospects. Bank of Greece and The Brookings Institution. pp 43–96

  • Gregory AW, Hansen BE (1996) Residual-based tests for co-integration in models with regime shifts. J Econ 70:99–126

    Google Scholar 

  • Gruber JW, Kamin SB (2007) Explaining the global pattern of current account imbalances. J Int Money Fin 26:500–522

    Article  Google Scholar 

  • Hakkio C, Rush M (1991) Is the budget deficit “too large”? Econ Inq 29:429–445

    Article  Google Scholar 

  • Herrmann S, Jochem A (2005) Determinants of current account developments in the central and east European EU member states-consequences for the enlargement of the euro area. Discussion paper series 1: Economic Studies 32, Deutsche Bundesbank

  • Holmes MJ (2006) How sustainable are OECD current account balances in the long run? Manchester School 74:626–643

    Article  Google Scholar 

  • Jappeli T, Pagano M (1989) Consumption and capital market imperfection: an international comparison. Am Econ Rev 79:1088–1105

    Google Scholar 

  • Krolzig HM (1997) Markov switching vector auto regressions. Modelling statistical inference and application to business cycle analysis, lecture notes in economics and mathematical systems, Springer, Berlin

  • Krolzig H, Marcellino M, Mizon GE (2002) A Markov-switching vector equilibrium correction model of the UK labour market. Empir Econ 27:233–254

    Article  Google Scholar 

  • Kwiatkowski D, Phillips PCB, Schmidt P, Shin Y (1992) Testing the null hypothesis of stationarity against the alternative of a unit root. J Econ 54:159–178

    Google Scholar 

  • Lee J, Strazicich MC (2004) Minimum LM unit root test with one structural break. Working papers 04–17, Appalachian State University

  • Lehmussaari OP (1990) Deregulation and consumption: saving dynamics in the Nordic countries. IMF Staff Papers 37. pp 71–93

  • Makrydakis S (1999) Consumption-smoothing and the excessiveness of Greece’s current account deficits. Empir Econ 24:183–209

    Article  Google Scholar 

  • Melitz J (1990) Financial deregulation in France. Eur Econ Rev 34:394–402

    Article  Google Scholar 

  • Nason JM, Rogers JH (2006) The present-value model of the current account has been rejected: round up the usual suspects. J Int Econ 68:159–187

    Article  Google Scholar 

  • Nickell C, Vansteenkiste I (2008) Fiscal policies, the current account and Ricardian equivalence. ECB working paper 935

  • Nocetti D, Smith WT (2010) Price variability and savings. Mimeo, available at http://ssrn.com/abstract=1538407

  • Obstfeld M, Rogoff K (1995) The intertemporal approach to the current account. In Grossman GM, Rogoff K (eds) Handbook of international economics, vol. 3, North-Holland. pp 1731–1799

  • Ostry JD, Levy J (1995) Household saving in France: stochastic income and financial deregulation. IMF staff papers 42. pp 375–397

  • Osugi K (1990) Japan’s experience of financial deregulation since 1984 in an international perspective. BIS economic papers 26

  • Perron P (1988) Trends and random walks in macroeconomic time series: further evidence from a new approach. J Econ Dyn Control 12:297–332

    Article  Google Scholar 

  • Phillips PCB (1987) Time series regression with a unit root. Econometrica 55:277–301

    Article  Google Scholar 

  • Phillips PCB, Hansen BE (1990) Statistical inference in instrumental variables regression with I(1) processes. Rev Econ Stud 57:99–125

    Article  Google Scholar 

  • Phillips PCB, Perron P (1988) Testing for a unit root in time series regression. Biometrica 75:335–346

    Article  Google Scholar 

  • Sachs TD (1981) The current account and macroeconomic adjustment in the 1970s. Brook Papers Econ Act 1:201–268

    Article  Google Scholar 

  • Taylor AM (2002) A century of current account dynamics. J Int Money Fin 21:725–748

    Article  Google Scholar 

  • Trehan B, Walsh CE (1991) Testing intertemporal budget constraints: theory and applications to US Federal Budget and current account deficits. J Money Credit Bank 23:206–223

    Article  Google Scholar 

  • Zivot E, Andrews DWK (1992) Further evidence on the great crash, the oil-price shock, and the unit-root hypothesis. J Bus Econ Stat 10:251–270

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Sophocles N. Brissimis.

Rights and permissions

Reprints and permissions

About this article

Cite this article

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

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10644-011-9107-y

Keywords

JEL Classification

Navigation