Current Account Adjustment and Capital Flows*

Abstract

We examine episodes of current account adjustment in industrial countries over the past 30 years. We find that they were typically associated with a sizable growth slowdown and a large exchange rate depreciation. There was no discernible change in the nature of capital flows just prior to an adjustment. Hence, adjustments may be responding to the resolution of domestic imbalances rather than being an exogenous event. We show that global developments triggered the adjustment, possibly by triggering the unwinding of the domestic imbalances. Most of the ex post adjustment of the financial account was in private sector flows, primarily by foreign investors. Copyright � 2007 The Authors; Journal compilation � 2007 Blackwell Publishing Ltd.

Current Account Reversals in Industrial Countries: does the Exchange Rate Regime Matter?

“…While some current account reversals indeed coincide with growth declines, the authors do not find any supportive evidence for a causal link between the reversal itself and the fall in growth. Debelle and Galati (2007) come to the same conclusion. 3 However, the inability of these studies to identify a link between reversals and growth may be due to the fact that they do not distinguish countries with fixed from those with more flexible exchange rate regimes.…”

“…Within this context, an interesting question is whether the reversal itself has an impact on growth that is independent of the factors that caused the correction. Croke et al (2006) and Debelle and Galati (2007) studied the link between current account reversals and economic growth in industrial economies. Their work does not find any significant evidence in support of a causal link between the reversal and the fall in growth.…”

Patterns of Current Account Adjustment—Insights from Past Experience

“…Freund and Warnock (2006) study the composition of financial flows but do not find a systematic relation with current account adjustments. Also Debelle and Galati (2005) examine the role of financial flows, highlighting that financial account variables help explain why countries run a large current account deficit, but not why they go through a current account adjustment.…”

“…A number of authors have estimated the likelihood of a current account adjustment using discrete choice models (Adalet and Eichengreen, 2006;Benhima and Havrylchyk, 2006;de Haan et al, 2006;Debelle and Galati, 2005;Edwards, 2005c;Freund, 2005;Milesi-Ferretti and Razin, 2000). In these models, the dependent variable takes two values, 1 during the first year of adjustment and 0 otherwise.…”

The Modality of Fiscal Consolidation and Current Account Adjustment

“…Thus, the subsequent literature (e.g. Freund (2005), Croke, Kamin, and Leduc (2005), Freund and Warnock (2007), Debelle and Galati (2007), Adalet and Eichengreen (2007), Algieri and Bracke (2011)) has followed the same general methodology, but has relaxed some of the earlier criteria in order to maximize the number of identified episodes. We adopt a similar strategy in the present paper, and we identify an adjustment episode when all of the following conditions are satisfied (variations of these conditions are also examined):…”