Intertemporal sustainability of current account imbalances: New evidence from the OECD countries

Abstract

This study estimates the intertemporal model for the relationship between exports and imports and examines the sustainability of current account deficits (CADs) and the validity of intertemporal budget constraint for 24 Organisation for Economic Co‐operation and Development countries. The standard ordinary least squares (OLS)‐based two‐step Engle and Granger test, the cointegration regression Durbin–Watson (CRDW) test, and the Stock–Watson test performed on the one‐regime model with time‐invariant parameters and no structural break provide mixed support for the presence of cointegration between exports and imports. The recursive least squares‐based cumulative sum of recursive residuals (CUSUM) and the cumulative sum of squares of recursive residuals (CUSUMSQ) tests and the OLS‐based Andrews‐Quandt (AQ) and Andrews – Ploberger (AP) tests suggest the presence of structural breaks in the long‐run relationship between exports and imports for a number of countries. The end‐of‐sample new cointegration breakdown tests performed on the OLS, fully modified OLS, and full‐information maximum‐likelihood estimates of the model suggest the presence of cointegration between exports and imports for most countries. The dominant support for cointegration between trade flows points toward the sustainability of CADs and the validity of intertemporal budget constraint. The macroeconomic stabilization policies seem to have been effective in correcting the market failures and maintaining the steady‐state equilibrium relationship between trade flows in the sample countries. The findings of this study have important implications for empirical research. The structural breaks in the cointegrating vector could occur even over the short time periods and at any point in time. It is essentially important to assess the sustainability of the external position in the presence of long‐period as well as short‐period breaks in the cointegrating vector.

Are the Current Account Imbalances on a Sustainable Path?

“…Our first sub-sample covers the period 1970-1999 to allow for sufficient time series observations. We found that the studies by Singh (2015Singh ( , 2019 are similar to ours in this regard. Singh (2015Singh ( , 2019 conducted similar sub-sample analyses and tested for what he referred to as "a break down in cointegration between exports and imports" for the case of India and the OECD nations, respectively.…”

“…We found that the studies by Singh (2015Singh ( , 2019 are similar to ours in this regard. Singh (2015Singh ( , 2019 conducted similar sub-sample analyses and tested for what he referred to as "a break down in cointegration between exports and imports" for the case of India and the OECD nations, respectively. His results show that there is a breakdown of the cointegration relationship over some periods.…”

“…Husted (1992) built the intertemporal solvency condition for a nation on the basis of a mean reverting current account imbalances and a long-run equilibrium relationship between exports and imports. Several studies examine the solvency test by assessing the cointegration relationships between exports and imports of developed nations (see, Leachman and Thorpe 1998;Liu and Tanner 1996;Önel and Utkulu 2006;Singh 2019;Wickens and Uctum 1993); and emerging and transition nations (see, Hassan et al (2016) for Middle East and African (MEA) countries; Wadud et al (2015) for Bangladesh; Singh (2015) for India; Gnimassoun and Coulibaly (2014) for Sub-Saharan Africa; Holmes et al (2011) for India; Greenidge et al (2011) for Barbados; Pattichis (2010) for Cyprus; Yol (2009) for Tunisia and Egypt and for Morocco; Ismail and Baharumshah (2008) for Malaysia; for 22 least developed countries; Narayan and Narayan (2004) for Fiji and Papua New Guinea; and Baharumshah et al (2003) for four ASEAN nations).…”

“…We found that only a few studies allow for structural breaks for solvency tests (see Baharumshah et al (2003) for four ASEAN countries; Önel and Utkulu (2006) for Turkey, Singh (2015) for India; Singh (2019) for OECD countries). Singh (2019), which is one of the latest studies, tested the solvency condition with data leading up to 2006, and found support for current account sustainability in the presence of structural breaks.…”

“…We found that only a few studies allow for structural breaks for solvency tests (see Baharumshah et al (2003) for four ASEAN countries; Önel and Utkulu (2006) for Turkey, Singh (2015) for India; Singh (2019) for OECD countries). Singh (2019), which is one of the latest studies, tested the solvency condition with data leading up to 2006, and found support for current account sustainability in the presence of structural breaks. Our study provides new evidence, using extended data on developed nations up to 2018, to allow for recent economic/financial challenges in the form of the global financial crisis and the European sovereign debt crisis.…”