Structural Change in Current Account and Real Exchange Rate Dynamics: Evidence from the G7 Countries

Abstract

Lee and Chinn (2006) and Chinn and Lee (2009) decomposed the current account and real exchange rate into temporary and permanent shocks, and argued that a temporary shock creates the combination of current account surplus (deficit) and real exchange rate depreciation (appreciation). This paper extends their framework by examining a possible structural break in the current account and real exchange rate dynamics. Using the data of the G7 countries during the period 1980-2007, we find structural changes in two-variable dynamics for all the countries during the mid 1990s. Since the mid 1990s, the temporary shocks have not been the main source of fluctuations in the current account. Our empirical results imply that the conventional mechanism has played a limited role in explaining the dynamics of the two variables.

Keywords: Current Exchange Rate, Structural Change, Global Imbalances

JEL Classification: F31, F41