Causal Relationship Between the Current Account and Financial Account

Abstract

We demonstrate that a different causal relationship exists between the current and financial accounts in developed and developing countries. Using the Granger causality test, we clearly determine that the financial account is by and large responsible for the current account in developing countries; instead of financing the current account, the financial account thrusts the current account into an imbalance. In developed countries, however, the current account leads the way, and the financial account, as its name indicates, serves to finance a current account imbalance. This represents a forewarning that countries, which lack a sophisticated financial system to channel funds to proper locations, should not recklessly liberalize capital mobility. Copyright International Atlantic Economic Society 2005F32,

Causal relationships between the capital account and the current account: an empirical investigation from India

“…Following Yan (2005Yan ( , 2007 and Kim and Kim (2011) we include real effective exchange rate along with the CA and the KA to estimate the following system of equations. …”

“…However, Faroque and Veloce (1990) and Kim and Kim (2011) found a bidirectional causality in the case of Canada and Korea, respectively. Yan (2005) found causality running from the CA to the KA in the case of developed countries whereas in the case of emerging economies the causality runs the other way around.…”

“…Although the KA liberalization is expected to increase savings and investment, and thereby higher economic growth 1 , it could lead to deterioration of the current account (CA) in the absence of a wellestablished financial system (Yan, 2005(Yan, , 2007. High capital inflows due to the liberalization in the KA may lead to real exchange rate appreciation of the domestic currency, loss of export competitiveness and subsequently leads to the CA deficit (Cooper, 2001;Kim et al, 2004;Prasad and Rajan, 2008).…”

The Connection between the Exchange Rate and the Balance of Payments Accounts in the Czech Republic: An Econometric Approach

“…However, for short-term flows, the direction changes over the business cycle: financial account components finance the current account during economic downturns while inducing its changes during upturns. In Yan (2005), Yan and Yang (2008) and Guerin (2004) Granger causality tests were implemented to find out that the financial account is responsible for the current account in developing countries -instead of financing the current account, the financial account thrusts the current account into an imbalance. Ersoy (2011) used Granger causality analysis under a VAR framework to reach the same conclusion for the Turkish economy -unidirectional causality runs from the financial account to the current account.…”

On the Relation between Capital Flows and the Current Account

“…Their relation to the current account might therefore differ. 5 Studies in the literature analysing the relationship between the current and financial account mainly focus on the difference between developing and developed countries (Fry et al 1995, Sarisoy-Guerin 2003, Yan 2005, Yan and Yang 2012 or provide applications to emerging market economies (Yan and Yang 2008, Kim and Kim 2011, Lau and Fu 2011, Garg and Prabheesh 2015. Generally, findings suggest that the Granger-causality runs from the current account to the financial account in developed countries, while it is the reverse case in developing countries.…”