This paper analyzes the mean-reverting behavior of the current account in five crisis-affected Asian countries. Our key findings are as follows. The conventional linear unit-root test (the ADF test) fails to reject the existence of a unit root in the ...
This paper analyzes the mean-reverting behavior of the current account in five crisis-affected Asian countries. Our key findings are as follows. The conventional linear unit-root test (the ADF test) fails to reject the existence of a unit root in the current accounts of all countries except for the Philippines. The existence of a unit root is rejected in favor of nonlinear mean reversion for all countries except Thailand. These nonlinear unit-root test results imply that, with the exception of Thailand, the current accounts of these countries over the past three decades have been on sustainable paths. This evidence for the mean-reverting behavior of these countries’ current accounts also provides support for the intertemporal model of the current account.
The financial crisis of 1997 raised some questions as to whether policy-makers might have contributed to the crisis by not dealing adequately with the large current-account deficits, which meant that these countries relied very heavily on massive foreign capital inflows. These excessive current-account deficits also led some experts to claim that the current accounts were not on sustainable paths. However, our results indicate that these countries’ current accounts display a mean-reverting behavior, implying that their current-account deficits could not have degenerated into an external crisis.
We could not find evidence for any threshold in the current-account adjustment. We also found that the nonlinear mean-reverting behavior of these countries’ current accounts is best described by the ESTAR model rather than by either the DTAR or DLSTAR models.
The results of variance decomposition and impulse response function analyses indicate that dramatic improvements in the current-account deficits of these countries around 1998 were caused by sharp real depreciations of their currencies against those of their major trading partners. Contrary to most industrialized countries, the slowdown of these countries’ real GDP growth rates did not play a critical role in reducing their current-account deficits.
Finally, policy implications are as follows. Among others, the most important finding of this study argues that using monetary or fiscal policy based on simple unit root test will be misleading and can cause dynamic inconsistency problem for that country. However, for countries like Thailand, when the current account is proven to be unsustainable with linear and nonlinear unit root tests, government has a strong incentive to bring in monetary or fiscal policies.
However, there are serious policy constraints when we try to reverse the unsustainable current account deficit into sustainable one. No policy mix can avoid long-run significant realignment of exchange rates which will, not only, increase expected exchange rate volatility (Obstfeld and Rogoff, 2004; Rogoff, 2006), but also, have a strong negative impact on growth and employment (Edwards, 2006).
Taking those constraints in mind, first of all, fiscal adjustment (consolidation) is necessary. Especially, a couple of important tax policies are clear for Thailand. From the saving investment gap perspective, in order to stimulate private saving, she can (i) reduce the marginal income tax rates, (ii) cut tax rates on corporate equity dividend and capital gains or transform the tax system to a "broad-based" income tax or consumption tax which will significantly increase annual output per worker (Hubbard, 2006).