Is an Intertemporal Model of the Current Account Valid for East Asian Countries? Evidence From Structural Var

Abstract

This paper aims to examine the validity of present-value model of current account (PVMCA) by analyzing dynamic responses of variables in PVMCA to structural shocks. In place of the cross-equation restriction tests used in existing research, we adopted a structural vector autoregression framework and obtain three findings. First, evidences from 4 East Asian countries supported the intertemporal theoretical expectation that country-specific transitory shocks significantly affect current accounts, whereas the effects of global and country-specific permanent shocks are negligible. Second, country-specific transitory shocks that primarily affected current account variance dominate net output variation. Third, global permanent and transitory shocks mainly affecting variances in world interest rates and exchange rates secondarily explain current account variance. Therefore, three explanatory variables of PVMCA sufficiently explain current account variations. In practice, investors can use the PVMCA to forecast changes in current accounts; they further judge business risks stemming from the changes, and adjust their security portfolio.

Causes of Current Account Fluctuations in West African Monetary Union

“…In other words, transitory specific shocks are the dominant factor in the current account fluctuations of the WAEMU economies. This result confirms the fundamental assumption of the inter-temporal approach and corresponds to that found by other studies in particular, Gregory and Head (1999) for the G7 economies, Kano (2003) in the framework of Canada and the United Kingdom and Kuo (2015) with regard to East Asian countries.…”

“…This result is consistent with the theoretical predictions of the inter-temporal approach, which states the absence of a current account response to the global shock in a small open economy. This has also been empirically established by recent studies such as Gross (2001) and especially Kuo (2015) in the context of East Asian economies.…”

“…The analysis of impulse response functions also focuses on the responses of net output to global, specific and permanent shocks. Indeed, one of the strong conclusions of the intertemporal approach is that the shocks that determine the dynamics of the current account are identical to those that affect the changes in net output (Kuo, 2015). Therefore, we also analyze the reactions of net output to different structural shocks.…”

Current account dynamics: A SVAR analysis when the country‐specific shocks are correlated at leads

“…One technique to analyze the PVM predictions is building a SVAR specification using Blanchard and Quah (1989)'s identification (BQ) to identify the persistence of the structural shocks. Under this setup, some literature include Kano (2008), Kuo (2015), Ibhagui (2017), Diallo (2020), and Bussiere et al (2021). Kano (2008) employed the basic model with uncertainty to analyze Canada and the UK.…”

“…In addition, using a four-SVAR specification to address the consumption-tilting motive via the inclusion of the real exchange rate in the analysis, 3 Kuo (2015) found that temporary shocks play a major role in the current account and net output growth fluctuations. This implies that Kano's second puzzle does not hold for Hong Kong, India, Singapore, and Taiwan.…”