On the Relationship between Domestic Saving and the Current Account: Evidence and Theory for Developing Countries

48 Pages Posted: 15 Nov 2019 Last revised: 2 Dec 2019

See all articles by Evi Pappa

Evi Pappa

Universidad Carlos III de Madrid

Markus Brueckner

The Australian National University

Wojtek Paczos

Cardiff University - Cardiff Business School

Multiple version iconThere are 2 versions of this paper

Date Written: November 2019

Abstract

We examine the relationship between domestic saving and the current account in developing countries. Our three main findings are that domestic saving has: (i) a small effect on the current account; (ii) a significant positive and quantitatively sizable effect on the trade balance; (iii) a significant negative effect on net-current transfers. We use countries in the sub-Saharan African region as a laboratory for an instrumental variables approach. The IV approach enables to obtain estimates of causal effects. Underlying the IV approach is the significant positive first-stage response of domestic saving to plausibly exogenous annual rainfall: an unanticipated, transitory supply-side shock. We construct a small open-economy DSGE model with debt adjustment frictions and endogenous net-current transfers to match the empirical findings. The model enables to examine how other types of shocks - such as changes in interest rates or trend TFP for which it is hard to get exogenous variation in the data - affect the relationship between domestic saving and the current account. An important implication of our findings is that, for developing countries, estimates of the relationship between domestic saving and domestic investment are not informative for answering the question how domestic saving affects a country's accumulation of net foreign assets.

Keywords: current account, Domestic Saving, Feldstein-Horioka Puzzle, Financial Frictions, Net Current Transfers, Small Open Economy Model

JEL Classification: F32, F35

Suggested Citation

Pappa, Evi and Brueckner, Markus and Paczos, Wojtek, On the Relationship between Domestic Saving and the Current Account: Evidence and Theory for Developing Countries (November 2019). CEPR Discussion Paper No. DP14104. Available at SSRN: https://ssrn.com/abstract=3486255

Evi Pappa

Universidad Carlos III de Madrid ( email )

CL. de Madrid 126
Madrid, Madrid 28903
Spain

Markus Brueckner (Contact Author)

The Australian National University ( email )

Canberra, Australian Capital Territory 2601
Australia

Wojtek Paczos

Cardiff University - Cardiff Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom

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