Are Global Imbalances Sustainable? Shedding Further Light on the Causes of Current Account Reversals

Authors

  • Luiz de Mello,

  • Pier Carlo Padoan,

  • Linda Rousová

    Search for more papers by this author
    • The authors thank, without implicating, the participants of the conference on “Advances in International Economics and Economic Dynamics: A Conference in Honour of Giancarlo Gandolfo,” organised by the Research Centre of International Economics (CIDEI) and the Department of Public Economics of La Sapienza University of Rome on 20–21 September 2010, two anonymous referees and colleagues from the Organisation for Economic Co-operation and Development (OECD) Economics Department for helpful comments and discussions.


Abstract

Large shifts in countries' external current account positions can be disruptive, often reflecting sudden stops in the flows of external finance and leading to exchange rate and banking crises. As a result, an empirical literature has emerged on the sustainability of, and the determinants of large swings in, current account positions. Further light is shed on this issue by testing for the presence of unit roots in the current account balance-to-gross domestic product (GDP) ratios of a large set of mature and emerging-market economies using a methodology that allows for structural breaks in levels and trends. A chronology is constructed of current account reversals that is consistent with sustainability of external positions and it is used to estimate the factors explaining the likelihood and magnitude of such reversals by utilising a selection model with ordered probit in the selection stage. It is found that most of the factors that explain the probability of reversals, such as trends in capital flows, in the budget balance and in external positions, also influence their magnitude, but there are a few exceptions. For instance, the stance of monetary policy and the magnitude of external imbalances prior to a reversal seem to be more powerful predictors of the probability of reversals than of their magnitude.

Ancillary