Are Current Account Deficits Sustainable? Evidence from Dynamic Panel Data Analysis
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Are Current Account Deficits Sustainable? Evidence from Dynamic Panel Data Analysis Santosh Kumar Dash1
© The Indian Econometric Society 2020
Abstract This paper examines two issues, namely, whether the current account deficit (CAD) is sustainable, and the degree of sustainability for a panel consisting of 129 countries over the period 1981–2013. To this end, we investigate the relationship between exports and imports for various income and region categories. Our finding from the pooled mean group estimator suggests that CAD is “weakly” sustainable in most of the country groups. This implies that sustainable current account is consistent with the sustainability of external debts. Further, the adjustment coefficient is found to be rather low for all the country groups. This indicates that the speed of convergence toward the long-run equilibrium in the event of short-run disturbances is faster. Finally, we discuss policy implications of our findings. Keywords Imports · Exports · CAD · Current account sustainability · Panel ARDL · Pooled mean group estimator JEL Classifications F14 · F32 · F35
I. Introduction Current account plays a key role in a country’s macroeconomic stability. Hence, the long-run relationship between exports and imports have received substantial attention in the area of international trade (Husted 1992; Obstfeld & Rogoff 1996; Wu 2000). A widening gap between the two variables may indicate that the government may lack the ability to manage the economy. Even if a domestic economy is strong, if inflows dry up the government may find it difficult in raising foreign exchange in the event of a high current account deficit. As a consequence, investors will perceive government policies as unsustainable, and hence, the sudden capital flight * Santosh Kumar Dash [email protected] 1
Center for Excellence in Fiscal Policy and Taxation, Xavier University, Bhubaneswar, Odisha 751013, India
13
Vol.:(0123456789)
Journal of Quantitative Economics
might occur. Further, persistent large current account deficit can lead to currency crises (Kaminsky et al. 1998; Edwards 2001). Examples include Chile and Mexico (the early 1980s), Mexico and Argentina (mid-1990s), and more recently in East Asian countries (late 1990s). Hence, many studies have been devoted to testing the current account sustainability. Sustainability implies that an economy can meet its intertemporal budget constraint in the long run without a drastic policy change such as currency devaluation or sharp reduction in government expenditure. Thus, studying the sustainability of current account deficit (CAD) is important for the following reasons. First, if the current account is mean-reverting, it implies that external debt is sustainable1 and hence, the government has no incentive to default on its international borrowing. Second, the stationarity of the current account satisfies the modern inter-temporal model2 (Obstfeld and Rogoff 1996; Wu 2000). Husted (1992) used US quarterly data for the period 1967–1989 to empirically examine
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