Transcript Academy of Economic Studies Doctoral School of Finance and

Academy of Economic Studies
Doctoral School of Finance and Banking
Determinants of Current Account for
Central and Eastern European
Countries
MSc Student: Anca Apӑteanu
Coordinator: Professor Moisӑ Altӑr
Bucharest, July 2008
Contents
1.
2.
3.
4.
5.
Introduction
Literature Review
Theoretical Model
Empirical Research
Conclusions
Introduction
Objectives:
 Investigate the determinants of current account deficits
for the newest EU members

Answer the question whether the deficits run by these
countries are caused by the catching up processes they
experience

Address the issue of sustainability
Literature Review

Obstfeld and Rogoff (1996) developed the intertemporal
approach, according to which the current account balance
is the outcome of forward looking dynamic saving and
investment decisions;

Calderòn, Chong and Loayza (1999) focused on developing
countries and distinguish between transitory and permanent
components of current account deficits. They found that
current account deficit is moderately persistent and there
exists a negative relation between output growth rate and
current account;
Literature Review

Chinn and Prasad (2000) view current account balance as the
outcome of variations in structural and macroeconomic
determinants that influence the saving-investment balance.
The main findings are that current accounts are positively
correlated with fiscal balances and initial stock of net foreign
assets, but negatively correlated with the degree of openness;

Bussière, Fratzsher and Müller (2004) provide a study on 21
OECD countries and all EU acceding countries. The results
show that current account balances are highly persistent and
that fiscal balance has significant positive effects on current
account;
Literature Review

Aristovnik (2005) examines the dynamics and current account
sustainability of selected transition economies and concludes
that generally deficits higher than 5% GDP pose external
sustainability problems.
The Model
In line with the work of Chinn and Prasad we link the intertemporal
approach with the stage of development hypothesis.
The starting point is the identity of current account with the
difference of domestic saving and investment:
CA= SP+ SG-I
(1)
Equation 1 is divided by GDP for comparability purposes.
Private saving is a function of different variables:
SP/Y=f((Y/N)/(Y*/N*); REER, SG/Y, If/Y) (2)
The Model
SP/Y=α0+α1(PCI-PCI*)+α2REER+ α3SG/I+ α4If/Y+ε (3)
Substituting into equation (1) we obtain the regression to be
estimated:
CA/Y= SP/Y=α0+α1(PCI-PCI*)+α2REER+(1+ α3)SG/I+(α4-1)If/Y(4)
The variables:

Relative per capita income – real per capita income Y/N in relation to the
real per capita income of the reference country Y*/N*. Anticipating real
convergence and higher income in the future, consumers in developing
economies take on debt in order to smooth their long term consumption.
Therefore we expect a positive relation between relative per capita
income and current account balance.
The Model



Real effective exchange rate – tends to rise while the catching up
process takes place, so the expected sign is expected to be the same as
the one of the relative income. However, it has opposite effects
depending whether it is expected or unforeseen, permanent or transitory.
So the effect of real effective exchange rate can only be determined
empirically.
Fiscal balance – affects private savings. In case of Ricardian
equivalence a rise in government debt is fully compensated by additional
private savings. We expect a positive relation between fiscal balance
and current account.
Fixed investment – correlates with savings especially when access to
capital market is restricted, however they can be considered linked
reasons known in the literature as “home bias”
Data and Estimation Methodology

Our investigation is based on panel of 10 countries : Bulgaria,
Czech Republic, Estonia, Latvia, Lithuania, Hungary, Poland,
Romania, Slovakia and Slovenia.

We have used quarterly data series from 1998:1 to 2007:4

Data sources: Eurostat
IMF
National Bank of Romania
We have used EGLS (Estimated Generalised Least Square) for the
panel of 10 countries and TSLS and GMM for Romania

Results
Results

Lagged current account coefficient:




Relative Income:



0.49 shows the substantial persistence of the current account dynamics
The coefficient is in line with the findings of Chinn and Prasad (2003) and
Bussière, Fratzsher and Müller (2004)
Can be rationalized by habit formation behavior of private agent
0.02 indicates that a per capita income below average will be associated with
a current account deficit
It can be explained by the “stage of development hypothesis”
Investment ratio:


-0.21 denotes that and increase in this ratio by one percent will lower the
current account by 0.21 percent.
Can also be linked to the stage of development hypothesis, as the income
level of developing economies moves closer to that of EU, the need for
investment is likely to diminish.
Results

Fiscal Balance:




The coefficient is 0.13 which means that 13 percent of unit change in fiscal
balance is reflected in the current account
Confirms the twin-deficits hypothesis
Confirms that there is no complete Ricardian off-set of changes in the way the
public expenditure is financed.
Real Effective Exchange Rate:

The REER is not significant in the estimated equation
Results
In the second equation we
introduced two variable related to
the financial system. According to
Edwards (1995) they can be used
to explain the saving ratio.
NRIR represents the real interest
rate for deposits. It should, ceteris
paribus, have a positive effect on
current account.
M2GDP measure the development
of the financial system. Its
influence can only be determined
empirically because it opens up
both saving and investment
opportunities.
Results


Real Deposit Rate:

The coefficient is 0.0025 which shows a positive relation with the current account.
However the influence is very small
Money to GDP:

The coefficient is 0.012 is compliant with the economic literature
Results for Romania

The only significant factors are Investment,
M2GDP and deposit rate

The continuous increase of the deficit is
caused by a series of structural factor
influence.

Romania exports low technological
products and imports products of high
technological level.
Conclusions

Current account deficits in developing countries are mainly caused by the stage of
development. Developing countries face the need of importing technology and
investment
.

Consumption smoothing can also be a factor explaining high deficits in the early
stage of development.

Although the current account position does not require structural changes, it is not
risk free. It can pose a problem in case of set-backs in the course of a country’s
development.