On the Solvency of Nations: Cross-Country Evidence on the Dynamics of External Adjustment

39 Pages Posted: 15 Sep 2012 Last revised: 23 Sep 2012

See all articles by Ceyhun Bora Durdu

Ceyhun Bora Durdu

Board of Governors of the Federal Reserve System

Enrique G. Mendoza

National Bureau of Economic Research (NBER); University of Pennsylvania

Marco E. Terrones

International Monetary Fund (IMF)

Date Written: September 2012

Abstract

We test the hypothesis that net foreign asset positions are consistent with external solvency and examine the dynamics of external adjustment using data for 50 countries over the 1970-2006 period. Our analysis adapts Bohn's (2007) error-correction reaction function approach--which tests for a negative long-run relationship between net exports (NX) and net foreign assets (NFA) as a sufficiency condition for the intertemporal budget constraint to hold--to a dynamic panel framework. Pooled Mean Group and Mean Group error-correction estimation yield evidence of a statistically significant, negative response of NX to NFA. Moreover, we cannot reject the hypothesis that the response is largely homogeneous across countries. Our sensitivity analysis shows that the countries with relatively weaker fundamentals need to respond more strongly to the changes in NFA to keep their NFAs on a sustainable path.

Suggested Citation

Durdu, Ceyhun Bora and Mendoza, Enrique G. and Terrones, Marco E., On the Solvency of Nations: Cross-Country Evidence on the Dynamics of External Adjustment (September 2012). NBER Working Paper No. w18380. Available at SSRN: https://ssrn.com/abstract=2147091

Ceyhun Bora Durdu (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Enrique G. Mendoza

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

HOME PAGE: http://www.sas.upenn.edu/~egme/index.html

Marco E. Terrones

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-4329 (Phone)

HOME PAGE: http://imf.org/external/np/CV/AuthorCV.aspx?AuthID=171

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