When Do Long-Term Imbalances Lead to Current Account Reversals?

22 Pages Posted: 18 Jan 2010

See all articles by Kenza Benhima

Kenza Benhima

University of Lausanne

Olena Havrylchyk

CEPII, Centre d'Etudes Prospectives et d'Info. Internationales, Paris; Université Paris Ouest - Nanterre, La Défense - EconomiX

Abstract

We extend the literature on sharp reductions in current account deficits by taking into account not only short-term determinants, but also the deviation of net foreign assets from their long-run equilibrium level. First, we analyse the long-term relationship between net foreign assets and a set of explanatory variables and construct a measure of imbalances. Next, we model current account reversals by incorporating this new measure and compare the predictive power of this model with the baseline specification that does not account for long-term imbalances. Our new model has a superior performance in and out-of-sample, especially when we control for the sign of imbalances. We also find that low net foreign assets do not necessarily lead to sharp reductions in current account deficits; it is rather the situation when they are below their equilibrium level that triggers reversals. Finally, we document that our new measure of net foreign asset imbalances is important only for developing countries, whereas standard models perform well for industrial economies.

Suggested Citation

Benhima, Kenza and Havrylchyk, Olena, When Do Long-Term Imbalances Lead to Current Account Reversals?. World Economy, Vol. 33, Issue 1, pp. 107-128, January 2010. Available at SSRN: https://ssrn.com/abstract=1537443 or http://dx.doi.org/10.1111/j.1467-9701.2009.01206.x

Kenza Benhima (Contact Author)

University of Lausanne ( email )

Lausanne, Vaud CH-1015
Switzerland

Olena Havrylchyk

CEPII, Centre d'Etudes Prospectives et d'Info. Internationales, Paris ( email )

113 rue de Grenelle
Paris, F-75007
France

Université Paris Ouest - Nanterre, La Défense - EconomiX ( email )

200 Avenue de la République
Nanterre cedex, Nanterre Cedex 92000
France

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