Global Versus Country-Specific Productivity Shocks and the Current Account

Abstract

For G-7 countries over the period 1961-1990, there appears to be a strong and stable negative correlation between annual changes in the current account and investment. Here we explore this correlation using a highly tractable empirical model that distinguishes between global and country-specific shocks. This distinction turns out to be quite important empirically, as global shocks account for roughly fifty percent of the overall variance of productivity. An apparent puzzle, however, is that the current account seems to respond by much less than investment to country-specific productivity shocks. Given the near random walk behavior of these shocks, this observation would appear to contradict a central cross-equation inequality restriction implied by the intertemporal approach. We show analytically, however, that the theoretically-predicted current account response can be extremely sensitive to small changes in the degree of mean reversion in country-specific productivity; in general, the current account response is more sensitive than is the investment response. Our results thus support the view that there is a significant convergent component to country-specific productivity shocks.

Current Accounts in the Long and the Short Run

“…This is almost exactly the same as the average of country-by-country estimates reported inGlick and Rogoff [1995].…”

“…First, cross-country correlations between investment and the current account are weak (Penati and Dooley [1984], Tesar [1991]). Second, within countries the time-series correlation between investment and the current account is consistently negative (Glick and Rogoff [1995]). We document that these two stylized facts hold in our sample of countries in Figure 10.…”

“…On the one hand, the long run or cross-sectional correlation between investment and the current account is weak (Penati and Dooley [1984], Tesar [1991]). On the other hand, the short run or time-series correlation between investment and the current account is consistently negative (Glick and Rogoff [1995]). The theory presented here predicts that in the long run, portfolio rebalancing is small and the correlation between the current account and investment should be positive in creditor countries and negative in debtor ones.…”

Business Cycles in Small Open Economies: Evidence From Panel Data Between 1900 and 2013

“…Our article also provides new evidence of the role of common shocks to the existing literature on world business cycles. Structural studies such as Glick and Rogoff () and Gregory and Head () distinguish the effects of common and country‐specific shocks, but do not estimate the model. Therefore, they do not address our questions on business cycles in small open economies.…”

Habit Formation and the Present-Value Model of the Current Account: Yet Another Suspect

“…A global shock does not give a small open economy an opportunity to borrow or lend in international financial markets because all economies have identical preferences, technologies and endowments and hence react to a global shock symmetrically. For empirical tests of this prediction, see Glick and Rogoff (1995), İşcan (2000), Nason and Rogers (2002), and Kano (2008).…”