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POLICY RESEARCH WORKING PAPER 1825
Current Accounts in What is the current account
response to a transitory
Debtor and Creditor income shock? This model
Countries predicts that favorable income
shocks lead to current
account deficits in debtor
countries and current account
Aart Kraay surpluses in creditor
countries.
Jaume Ventura
The World Bank
Development Research Group
Macroeconomics and Growth Division
September 1997
l POLICY RESEARCH WORKING PAPER 1825
Summary findings
Kraay and Ventura reexamine a classic question in countries and international borrowing and lending take
international economics: What is the current account place to exploit good investment opportunities.
response to a transitory income shock such as a Despite its conventional ingredients, the model
temporary improvement in the terms of trade, a transfer generates the novel prediction that favorable income
from abroad, or unusually high production? shocks lead to current account deficits in debtor
To answer this question, they construct a world countries and current account surpluses in creditor
equilibrium model in which productivity varies across countries. Evidence from thirteen OECD countries
broadly supports this theoretical prediction.
This paper - a product of the Macroeconomics and Growth Division, Development Research Group - is part of a larger
effort in the group to study open-economy macroeconomics. Copies of the paper are available free from the World Bank,
1818 H Street NW, Washington, DC 20433. Please contact Rebecca Martin, room N11-059, telephone 202-473-9026,
fax 202-522-3518, Internet address rmartinl@worldbank.org. September 1997. (55 pages)
The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about
development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The
papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this
paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the
countries they represent.
Produced by the Policy Research Dissemination Center
Current Accounts in Debtor and
Creditor Countries
Aart Kraay
The World Bank
and
Jaume Ventura
M. I.T.
We are grateful to Rudi Dombusch for discussing these ideas with us. We also thank Daron
Acemoglu, Jakob Svensson and participants in seminars at Harvard, Princeton, MIT,
Rochester and The World Bank for their useful comments. Further comments are welcome.
Please contact the authors at akraay@worldbank.org (Kraay) or jaume@mit.edu (Ventura).
Introduction
This paper reexamines a classic question in international economics: What is
the current account response to a transitory income shock such as a temporary
improvement in the terms of trade, a transfer from abroad or unusually high
production? To answer this question, we construct a world equilibrium model in
which productivity varies across countries and international borrowing and lending
takes place to exploit good investment opportunities. Despite its conventional
ingredients, the model generates the novel prediction that favourable income shocks
lead to current account deficits in debtor countries and current account surpluses in
creditor countries. Evidence from thirteen OECD countries broadly supports this
prediction of the theory.
A simple thought experiment reveals how natural our result is as a
benchmark case. Consider a country that receives a favourable transitory income
shock. Suppose further that this country saves this shock and has two investment
choices, domestic capital and foreign loans. To the extent that the shock does not
affect the expected profitability of future investments at home and abroad, a
reasonable guess is that investors allocate the marginal unit of wealth (the income
shock) among assets in the same proportions as the average unit of wealth. Since
by definition the share of a debtor country's wealth invested in domestic capital
exceeds one, an increase in wealth (savings) results in a greater increase in
domestic capital (investment), leading to a deficit on the current account (savings
minus investment). Conversely, in creditor countries the increase in wealth exceeds
investment at home, as a portion of this wealth increase is invested abroad. This
produces a current account surplus in creditor countries.
I
The sharp result that comes out of this simple example follows from three
assumptions. First, the income shock is saved. Second, investing in foreign capital is
not an option for the country. Third, the marginal unit of wealth is allocated among
assets as the average one is. We maintain the first two assumptions throughout the
paper without (excessive) apologies. The first assumption is a basic tenet of
consumption-smoothing models of savings. Despite some empirical failures of the
simplest of these models, we feel the jury is still out regarding the relative
importance of consumption-smoothing as a savings motive at the business cycle
frequency that we focus on here.' The second assumption can be easily removed.2
If we keep the other assumptions, a favourable income shock still leads to a current
account deficit if and only if the share of domestic capital in the country's wealth
exceeds one or, equivalently, if and only if foreign debt exceeds the stock of
outward foreign investment. Otherwise a favourable income shock leads to a current
account surplus.
The bulk of the theoretical effort of this paper is devoted to assessing the
merit of the third assumption underlying our simple example, namely, that the
marginal unit of wealth (savings) is invested in the same proportions as the stock of
wealth. To do so, we construct a simple world equilibrium model in which productivity
varies across countries and intemational borrowing and lending takes place to
exploit good investment opportunities. In the model, we distinguish between
production uncertainty and random changes in technology. In each date, some
countries have "good" production functions that exhibit high average productivity,
while other countries have "bad" production functions that exhibit low average
1 The importance of consumption-smoothing depends on the frequency of the data one is
analyzing. It is obviously important for the analysis of quarterly data (most people spend more
than they eam over Christmas and other holidays, and somewhat less than they earn in other
times), and almost as surely is a bad theory for understanding savings rates over a quarter of
a century. See Deaton (1992) for a survey of evidence on intertemporal models of savings.
2 Moreover, this assumption is consistent with the strong home equity preference in OECD
economies that has been documented by French and Poterba (1991) and Tesar and Werner
(1992). Lewis (1995) surveys alternative explanations for this phenomenon.
2
productivity. In normal times, production functions do not change but output is
uncertain. We use the term output shock to refer to production surprises. These
shocks do not affect the probability distribution of future productivity and, as a result,
they have only transitory income or wealth effects on investors. Occasionally,
countries perform economic reforms or experience changes in their economic
environment that change their "bad" production functions to "good" ones, or vice
versa. These events have persistent effects on the average level of productivity,
and we label them productivity shocks. Since productivity shocks change the
probability distribution of future productivity, they both have income or wealth effects
on investors, and also affect their investment strategies.
In our basic model, we assume that investors exhibit constant relative risk
aversion and have no labour income. As a result, the shares of wealth invested in
domestic capital and foreign loans depend only on asset characteristics, i.e.
expected retums and volatilities. Since these are not affected by output shocks, we
find that the marginal unit of wealth (the output shock) is invested as the average
one is. Since countries with high productivity are debtors, we find that positive output
shocks lead to current account deficits in these countries, and to current account
surpluses in creditor countries. This distinction does not apply to productivity shocks.
We find instead that favourable productivity shocks always lead to current account
deficits, as investors react to the increase in the expected return to domestic capital
by increasing their holdings of domestic capital and reducing their holdings of foreign
loans. The usefulness of this benchmark model is that it highlights the set of
assumpbons that underlie our example: shocks have only transitory income effects,
investors exhibit constant relative risk aversion, and there is no labour income.
We then proceed to relax these assumptions. First, we find that if relative risk
aversion decreases with wealth, positive output shocks raise wealth and induce
investors to take riskier investment positions. As a result, the share of the shock
3
invested in rsky domestic capital exceeds its share in wealth. Second, we show that,
if labour income is less risky than capital income, positive output shocks raise the
ratio of financial to human wealth and hence expose the investor to greater risk.
This induces investors to take safer investment positions in their financial wealth,
and so the share of the shock invested in domestic capital falls short of its share in
financial wealth. We obtain a simple rule to determine when a positive output shock
leads to a current account deficit: the country's debt has to exceed a certain
threshold that depends on how attitudes towards risk vary with wealth and the size
of labour income. This threshold can be either positive or negative, and is zero in the
case of constant relative risk aversion and no labour income.
Our research naturally relates to existing intertemporal models of the current
3
account. The early generation of intertemporal models, such as Sachs (1981,1982)
Obsffeld (1982), Dombusch (1983) and Svensson and Razin (1983), were designed
to study the effects of terms of trade shocks and to develop rigorous theoretical
foundations for the Harberger-Laursen-Metzler effect. We share with these models
the notion that countries save transitory income shocks so as to smooth
consumption over time. However, since these models abstract from capital
accumulation, income shocks can only be invested in foreign loans. As a result they
predict that positive transitory income shocks lead to current account surpluses in all
countries.
Simply allowing for capital accumulation is not sufficient to obtain the main
result of this paper, however. Subsequent contributions by Sachs (1981), Persson
and Svensson (1985) and Matsuyama (1987) extended the early intertemporal
models to include capital accumulation by investors with perfect foresight. These
models were designed to analyze the current account response to persistent shocks
3See Obstfeld and Rogoff (1995) for a survey of these models.
4
to the profitability of investment.4 Since the assumption of perfect foresight implies
that the return to investment is certain, arbitrage requires that the marginal product
of capital equal the world interest rate. This condition, combined with the assumption
of diminishing retums at the country level, uniquely determines the domestic stock of
capital independently of the country's wealth. Hence, transitory income shocks which
raise wealth but do not affect the marginal product of capital are again only invested
in foreign loans, leading to current account surpluses in all countries.
One can understand our contribution as recognizing that investment risk has
important implications for how the current account reacts to transitory income
shocks. Once investment is modelled as a risky activity, the appropriate arbitrage
condition equates the return on investment to the world interest rate plus a risk
premium. Since the latter increases with the share of wealth held as risky domestic
capital, transitory income shocks which do not affect the profitability of investment,
but do raise wealth, must in part be invested in domestic capital for the arbitrage
condition to be satisfied. In particular, we find that the share of the income shock
that is invested in domestic capital exceeds the income shock itself in debtor
countries, but not in creditor countries.5
The paper is organized as follows: Section 1 develops the basic model.
Section 2 presents the main result of the paper. Section 3 explores the robustness
of this result. Section 4 presents empirical evidence for thirteen OECD countries.
Section 5 concludes.
4These shocks correspond to our productivity shocks.
5Zeira (1987) provides an overlapping-generations model of a small open economy in which
there is capital accumulation and investment risk. The latter arises from a stochastic
depreciation rate. This model is used to show that cross-country differences in the rate of time
preference could explain the Feldstein-Horioka finding that savings and investment are highly
correlated in a cross-section of countries. Interestingly, he finds a U-shaped relationship
between the steady-state level of debt of a country and its rate of time preference. He does
not however explore the effects of transitory income shocks, as we do here.
5
1. A Model of International Borrowing and Lending
The world equilibrium model presented here is based on the view that
intemational borrowing and lending results from differences in investment
opportunities across countries rather than differences in the rate of time preference.6
At each date, some countries have "good" production functions that exhibit high
average productivity, while other countries have "bad" production functions that
exhibit low average productivity. Investors in all countries are allowed to borrow and
lend from each other at an interest rate r, which is determined in world equilibrium.
We assume that the penalties for default are large enough that intemational loans
are riskiess. Firms own their capital stocks and are financed by sales of equity in
stock markets. We assume that the cost of operating in foreign stock markets is high
enough that only domestic investors and firms trade in the domestic stock market.
This is an extreme, yet very popular device to generate the strong home-equity
preference observed in real economies.7
We draw a distinction between production uncertainty and random changes
in the state of technology. In normal times, countries have time-invariant but
stochastic production functions. We use the term output shocks to refer to
production surprises which occur during these normal times. Since these shocks do
not affect the probability distribution of future productivity, they have only transitory
income or wealth effects on investors. Occasionally, countries perform economic
reforms or experience other changes in their economic environment that have
persistent effects on their average level of productivity. We label these events as
productivity shocks and model them as random changes in the production function.
6 See Buiter (1981) and cLarida (1990) for world equilibrium models in which borrowing and
lending is motivated by cross-country variation in rates of time preference.
7 See Obstfeld (1994) for a discussion of the effects of financial integration in a model similar
to ours.
6
Since productivity shocks change the probability distribution of future productivity,
they both have income or wealth effects on investors, and also affect their
investment strategies.
A number of simplifications serve to highlight the bare essentials of our
arguments. We consider a world with infinitely many atomistic countries, indexed by
j=1,2.... This allows us to rule out large-country effects and concentrate on the pure
effects of intemational linkages. Also, we assume that there exists a single good
which is used for consumption and investment. This device permits us to focus on
intertemporal trade and eliminate the complications that arise from commodity trade.
Finally, we restrict our analysis to the steady state of the model in which both world
average growth and the interest rate are constant. This allows us to focus on the
effects of country-specific shocks as opposed to global shocks. While these
assumptions simplify the analysis considerably, we are convinced that removing
them would not affect the thrust of our arguments.
Firms and Technology
Production is random. Let qj and kj be the cumulative production and the
stock of capital of the representative firm of country j. Also, define xj as the state of
technology of this country. Conditional on xi, the production function of the
representative firm is:
dqj = 7j -kj *dt+cs-kj *dGj (1)
where ca is a positive constant and the Ojs are Wiener processes with E[dOj]=O and
E[dOj2]=dt and E[d0j-dOm]=O if jm. Equation (1) is simply a linear production function
7
which states that, conditional on the state of technology, the flow of output (net of
depreciation) in country j is a normal random variable with instantaneous mean
E[dqj]=7rj-kj-dt and variance-covariance matrix defined by E[dqj2]=.-ki2.dt and
E[dqj.dqm]=O if jm. Realizations of the dOjs are output shocks. Since these shocks
do not change the probability distribution of future productivity, they have only
income or wealth effects on the owners of the firm, but do not affect their investment
strategies.
Average productivity varies across countries and over time. At each date,
half of the countries are in a high-productivity regime, IrC = x7, while the other half are
in a low-productivity regime, 7tj = x, with X < i7r. The dynamics of 7rj follow a Poisson-
directed process:
=O with probability 1- * dt
i =g(7rj) with probability +.dt (2)
i if -M = i
wvhere g(,) = -l- if 'r j = 9 ; +, i and w are positive constants with 7tC - O for all j. Then, the consumer's budget
constraint is:
da, =[(xi - r) * xj + r) * aj - c * dt + Cy * x; * aj * dODj (4)
This budget constraint illustrates the standard risk-return trade-off behind investment
decisions. If 7rj>r, increases in the share of wealth allocated to equity raise the
expected return to wealth by (irj-r)-aj, at the cost of raising the volatility of this return
by s-aj. In Appendix 1, we show that the solution to the consumer's problem is:
cJ =p. aj (5)
7 -r
x = (6)
Equation (5) states that consumption is a fixed fraction of wealth and is independent
of asset characteristics i.e. r, ij and a. This is the well-known result that income and
substitution effects of changes in asset characteristics cancel for logarithmic
consumers. Equation (6) shows that the share of wealth allocated to each asset
depends only on asset characterstics, i.e. r, xj and a, and not on the level of wealth,
aj. This is nothing but the simple investment rule we used in the example in the
introduction.
10
World Equilibrium
To find the world interest rate, we use the market-clearing condition for
intemational loans, ,(a, - kj) =0, and the investment rule in Equation (6) to obtain:
r _ s-a2 (7)
where 1 = lim-E 7 * - . In Appendix 1 we show that there exists a
j1 lim - .a,
steady-state in which both the world growth rate and the world average productivity
are constant. In what follows, we assume that the world economy is already in this
steady state.
Using the world interest rate in Equation (7) and the investment rule in
Equation (6) we find that the world distribution of capital stocks is given by:
kj = (1 + ) . a;(8)
Equation (8) states that the capital stock of a country is increasing in both its wealth
and its productivity. Interestingly, this world of stochastic linear economies does not
generate the usual corner solution of a world of deterministic linear economies in
which all the capital is located in the country or countries that have the highest
11
productivity. In the presence of investment risk, these extreme investment strategies
are ruled out by investors as excessively risky. In fact, since we have assumed that
productivity differences are not too large relative to the investment risk, i.e.
7t - 7 < a2, all countries hold positive capital stocks in equilibrium.
Although world average growth is constant, this world economy exhibits a
rich cross-section of growth rates. To see this, substitute Equations (5)-(7) into (4), to
find the stochastic process for wealth:
daj [(s+ a )c +Xa-p t+ i 7t)da
The growth rate consists of the return to the country's wealth minus the consumption
to wealth ratio. The first term in Equation (9) is the average or expected growth rate,
and is larger in high-productivity countries, since these countries obtain a higher
average retum on their wealth. The second term in Equation (9) is the unexpected
component in the growth rate, and is more volatile in high-productivity
countries, since these countries hold a larger fraction of their wealth in risky capital.
12
2. Determinants of the Current Account
The model developed above describes a world equilibrium in which high-
productivity countries borrow from low-productivity countries since the former have
access to better investment opportunities than the latter. The amount that high-
productivity countries borrow is limited only by their willingness to bear risks. To see
this, let fj be the net foreign assets of country j, i.e. fj=arkl , and use Equation (8) to
find that:
j = a i2 *a (10)
Since n le < ix, high-productivity countries are debtors, fj<0, while low-productivity
countries are creditors, fj>O. Equation (10) shows that, for a given level of investment
risk, the volume of borrowing and lending is larger the larger are the cross-country
productivity differentials. Also note that, for a given productivity differential, the
volume of borrowing is larger the lower is the investment risk. Finally, observe that a
country can move from lender to borrower (borrower to lender) if and only if it
experiences a positive (negative) productivity shock.10
Next we examine the behavior of the curent account in this world equilibrium.
First, we derive the stochastic process for the current account and comment on its
salient features. Second, we provide an intuition as to the main economic forces that
10 In this world, a .sudden and large current account deficit that tums a country from creditor to
debtor should be seen as a positive development. This notion is cleady at odds with widely-
held beliefs in policy circles.
13
determine how the current account responds to shocks. Throughout, we emphasize
the differences in the current account between debtor and creditor countries.'1
Current Account Paftems
Since the current account is the change in net foreign assets, i.e. df1, we
apply Ito's lemma to (10) and use Equation (9) to find the following stochastic
process for foreign assets:
dfj (+ 5 3 +7Ca M_p fj djt+ a+ )f,f ) j j iX-(1
Equation (11) states that net foreign assets follow a mixed jump-diffusion process
and provides a complete characterization of their dynamics as a function of the
forcing processes dOj and dxj (remember that do) = i * dt + dOj), and all the
parameters of the model a, p, +, 7c and iE.
Consider first the prediction of the model for the average or expected current
account in debtor and creditor countries. Taking expectations of (11) yields:
1' The reader might ask why emphasize the debtor/creditor distinction instead of the highAow
productivity distinction. There are two reasons. From a theoretical viewpoint, one could
defend this choice by pointing out that the debtor/creditor distinction is more robust. In our
model, only cross-country differences in average productivity determine whether a country is
a debtor or a creditor. If we assume, for instance, that high average productivity is associated
with high volatility in production, it is then possible that the high-productivity technology might
be unappealing enough to tum high-productivity countries into creditors (see Devereaux and
Saito (1997)). In this case, all the results presented in this paper would still hold true for the
debtor/creditor distinction, but not for the high/low productivity distinction. From an empirical
viewpoint and anticipating that the predictions of the model will be confronted with the data,
one could defend the use of the debtor/creditor distinction based on the observation that
existing measures of net foreign asset positions of countries are of much better quality than
those of their average productivity.
14
E [d%]< + f) +_.2_7-& -P]. fj. dt+ i) .fj . dt (12)
Equation (12) separates the expected current account into two pieces, which
capture the effects of expected savings and expected changes in asset returns,
respectively. The first term reflects consumption "tilting" by agents. If the expected
return to wealth exceeds (does not exceed) the rate of time preference, i.e.
(6 + + X -a2> (<) p, consumers will find it optimal to save (dissave) so as
to "tilt" their consumption profile. These savings or dissavings are allocated across
assets in the same proportions as the existing stock of wealth. Ceters paribus, this
means that, in growing economies, debtors countries on average run current
account deficits, while creditors have surpluses on average. The opposite is true in
economies with negative growth. The second term in Equation (12) captures the
effects of mean reversion in productivity. Since productivity in debtor countries is
above its long-run average, it is expected to decline, while the converse is true for
creditor countries. Reductions (increases) in productivity induce investors to reduce
(increase) their holdings of capital and instead lend (borrow from) abroad. Ceteris
paribus, this means that debtor countries on average experience current account
surpluses, while creditor countries on average experience deficits. The balance of
the two effects is ambiguous in growing economies, and depends on all the
parameters of the model. The faster the economy grows and the smaller the mean-
reverting component of productivity is, the more likely it is that on average debtors
run current account deficits and creditors run current account surpluses.
15
Both output and productivity shocks contribute to the variance of the current
account. To see this, note that it follows from Equation (1 1) and the definitions of the
shocks that:
:~~~~~~~~~~~~~~~~~~~
Va[:( .f +f dt (13)
In normal times (i.e. with probability close to one) d7cj=O and fluctuations in the
current account are driven by the output shocks. These shocks have small effects
(of order dt~A) but occur with high probability (of order 1). Their contribution to the
variance of the current account is captured by the first term of Equation (13). At
some infrequent dates (i.e. with probability close to zero) diijO and the behavior of
the current account is dominated by productivity shocks. Although these shocks
occur with small probability (of order dt), they do have large effects on the current
account (of order 1) since they induce a reallocation of investors' portfolios. Their
contribution to the variance of the current account is captured by the second term of
Equation (13).
The Current Account Response to Shocks
We are now ready to examine perhaps the most novel finding of this paper,
that the response of the current account to an output shock depends on whether a
country is a debtor or a creditor. This result follows directly from Equation (1 1).
Since a + -> 0, a positive output shock, i.e. dth>a, leads to a current account
deficit in debtor countries and a current account surplus in creditor counties. To
develop an intuition for this result, we focus on the savings-investment balance.
16
The permanent-income consumers who populate our world economy save in
order to smooth their consumption over time. Since the output shock represents a
transitory increase in income, it is saved (recall Equation (9)). This is true regardless
of whether a country is a debtor or a creditor, and is a typical feature of intertemporal
models of the current acount.
Having decided to save the output shock, investors must then decide how to
allocate these additional savings between domestic equity and foreign loans. We
depart from previous intertemporal models of the current account in how we model
this decision. Since the investores desired holdings of equity are equal to the
country's stock of capital in equilibrium, Equation (6) can be interpreted in terms of a
familiar arbitrage condition:
7 =r+o2 ._ (14)
a.
Equation (14) states that expected rate of return to equity, 7ij, must equal the world
interest rate, r, plus the appropriate risk or equity premium, a2-(k 0, the second term of Equation (11) shows that a positive
productivity shock, i.e. d7ir>0, generates an income effect that leads to a current
account deficit in debtor countries and a current account surplus in creditor
countries. This effect is formally equivalent to that of an output shock and requires
no further discussion.
Second, a productivity shock has a rate-of-retum effect on investment since it
changes the probability distribution of future productivity.13 When a creditor (debtor)
country receives a positive (negative) productivity shock, the expected return to
equity increases (falls). This induces investors to hold a larger (smaller) fraction of
their portfolio in domestic equity and, as result, generates an investment boom
12 The large equity premium observed in the data suggests that investment risk is an
important feature of real economies. A prediction of this model is that this equity premium,
a2+.j-,n should be larger in debtor countries. To the best of our knowledge, this result is new
and has not been tested yet.
13 As Equation (5) shows, income and substitution effects of changes in the expected return to
equity cancel in our world of logarithmic consumers. In models with more general preferences
these rate-of-return effects of productivity shocks could be associated with consumption
booms or busts, depending on the balance of their income and substitution effects.
18
(bust). The counterpart of this investment response is a current account deficit
(surplus) and is reflected in the third term of Equation (11). Since rate-of-retum
effects of productivity shocks consist of reallocations in the stocks of assets, their
effects on the current account are much larger (of order 1) than the income effects
of the same shocks (of order dt).14 Since productivity shocks are infrequent but have
large effects, they would show up as large spikes in a time series of the current
account.
14 And, for that matter, much larger than the income effects of output shocks (of order dt/).
19
3. Investment Strategies
The theory developed above predicts that the current account response to
output shocks is different in debtor and creditor countries. Instrumental in deriving
this result were our assumptions regarding how investors trade risk and return.
These assumptions ensured that the marginal and average propensities to invest in
foreign loans coincide. However, there is a long and distinguished literature that
analyzes how optimal investment strategies depend on attitudes towards risk, the
size and stochastic properties of labour income and the correlation between asset
retums and changes in the investment opportunity set and other aspects of the
investor's environment.15 A general finding of this literature is that one should not
expect that marginal and average propensities to invest coincide.
The purpose of this section is to show that a modified version of our result
holds in a generalized model that allows attitudes towards risk to vary with the level
of wealth and introduces riskless labour income.16 In the generalized model
presented here, marginal and average propensities to invest in foreign loans differ.
However, we find a simple rule which determines when a positive output shock leads
to a current account deficit: the country's debt has to exceed a threshold that
depends on (1) how attitudes towards risk vary with wealth, and (2) the size of
labour income. This threshold can be either positive or negative, and is zero in the
benchmark case of constant relative risk aversion and no labour income. We
therefore have the modified result that favourable output shocks lead to current
15 See Merton (1995) for an overview of this research, and Bodie, Merton and Samuelson
1 992) for an example with risky labour income.
6We do not explore the implications for our argument that arise from the possibility that
asset returns be correlated with changes in the investors' environment. These correlations
give rise to a hedging component in asset demands that greatly depends on the specifics of
the model.
20
account deficits in sufficiently indebted countries. Otherwise, they lead to current
account surpluses.
Two Extensions
To allow attitudes toward risk to vary with the level of wealth, we adopt the
following Stone-Geary utility function:
EJln(cj + j) * ePt *dt 15)
0
where the f3js are constants, possibly different across countries. The coefficient of
relative risk aversion, i.e. j , varies across countries and overtime, as follows.
cj +Pj
For a given level of consumption or wealth, risk aversion is decreasing in %j. More
important for our purposes, if Pj0), investors exhibit decreasing (increasing)
relative risk aversion as their level of consumption increases. 17
To introduce labour income, we assume that there is an additional
technology that uses labour to produce the single good. 18 Normalizing the labour
force of each country to one, the flow of output produced using the second
technology is given by Xi ' dt. Labour productivity, k,is assumed to be constant
although it might vary across countries. Workers are paid a wage equal to the value
17 As is well-known, consumers with Stone-Geary preferences might choose negative
consumption. We ignore this in what follows.
18 The assumption of an aggregate linear technology between labour and capital is much less
restrictive that it might seem at first glance. It arises naturally in models where some form of
factor-price-equalization theorem holds. One could, for example, use the model in Ventura
(1997) to endogenously generate a linear technology. We do not do so here to save notation.
21
of their marginal product, i.e. X).dt. The existence of labour income complicates only
slightly the consumers budget constraint:
daj = [((7j -r)*xj +r)*aj +1j - ci]dt+x, -aj -a.dc k (16)
To ensure that all countries hold positive capital stocks in equilibrium, we assume
that aj(O)> >xi2 -
7i -a2
The representative consumer residing in country j maximizes (15) subject to
the budget constraint (16) and the (correct in equilibrium) belief that r is constant and
ixj follows the dynamics in Equation (2). In Appendix 1, we show that the solution to
this generalized consumees problem is:
( . Xi +j) (17)
( r+ *P a, j ) c (18)
Equations (17) and (18) illustrate how optimal consumption and investment rules
depend on both attitudes towards risk and the presence of labour income. Note first
that if consumers exhibit constant relative risk aversion, Pj=O, and there is no labour
income, Xj=O, Equations (17) and (18) reduce to the consumption and investment
rules of the previous model (Equations (5) and (6)). As before, consumption is linear
in wealth and income and substitution effects of changes in the expected return to
equity cancel. Equation (18) shows that the share of wealth devoted to equity
decreases with wealth if and only if j+p,j>O. To interpret this condition, note first that
if Pj>O, consumers exhibit increasing relative risk aversion, and so choose to allocate
22
a smaller share of wealth to risky domestic capital as their wealth increases.
Second, note that in the presence of riskiess labour income, Xj >0, increases in
financial wealth raise the ratio of financial to human wealth, and, ceteris paribus,
expose the investor to greater risk. In response, agents adopt less aggressive
investment strategies, and the share of financial wealth devoted to risky domestic
capital falls. Finally, holding constant the level of wealth, investors with low relative
risk aversion, i.e. high values of f3j, and/or a relatively large stream of riskless labour
income, i.e. high values of Xj, will devote a larger share of their wealth to risky
domestic capital.
World Equilibrium
To compute the world equilibrium interest rate, we impose once again the
I J
market-clearing condition for international loans, lim I Ea, -kj =0 and use the
investment rule (18) to find that Equation (7) is still valid. Appendix 1 shows that, if
I J
limm. * Xk + ,j = 0, there exists a steady-state in which both the world growth rate
and world average productivity are constants. In what follows, we assume that this
restriction regarding the cross-country distribution of parameters is satisfied and that
the world economy is in the steady state.
The world distribution of capital stocks is now given by a straighfforward
generalization of Equation (8):
k~ =(aXJ +.(i)J (19)
23
As before, the capital stock of a country is increasing in both its productivity and
wealth, and moreover, the world distribution of capital stocks is non-degenerate
since the restrictions that a,(0) > 2 and X - _ < CT, jointly ensure that all
countries hold positive capital stocks in equilibrium.19 In addition, countries whose
residents have a high tolerance for risk and/or high labour productivity, i.e. high Pi
and/or bj, have large domestic capital stocks.
We find, once more, that while the world average growth rate is constant, the
world economy exhibits a rich cross-section of growth rates. To see this, substitute
Equations (17)-(18) and (7) into the budget constraint in Equation (16) to obtain:
daj =0 X s - 7c2 + a 2 -.1+Xi + i ) t+6+7r - ) 1 4+8 ).d
aj L + dt a;9 *r (7 -62 a, * 6i-
(20)
As before, high productivity countries grow faster and experience more volatile
growth than low productivity countries. Perhaps the most interesting difference
between this growth rate and the special case in Equation (9) is that, if Xj+fj>0
(Xj+f3jO (Xj+,3jO (Xj+,3j 0, Equation (21) shows that a positive output shock, i.e.
X. +f3
dOj>O, leads to a current account deficit in countries where f + J < 0 and a
surplus in countries where f + i pi > 0. This result is again best understood in
terms of the savings-investment balance. As in the model of the previous section,
savings behaviour is very standard and reflects the desire of agents to smooth their
consumption in the face of transitory income shocks. Where our results differ from
the existing current account literature is in how these savings are allocated across
assets. Rearranging Equation (18), we obtain the following generalization of the
arbitrage condition in Equation (14).
Xi =r+CYa (. f2).a1 +X (23)
26
The risk premium is the product of two terms. The first is the covariance between the
return on equity and the return on an investor's portfolio, which is greater the larger
is the volatility of equity returns and the larger is the share of wealth invested in
domestic equity, a .(kj/aj). The second term is the coefficient of relative risk aversion
(I a2 ) ai 20
of the investor's value function, / . In the model of the previous
(it-C 2)- a; + x +Oj
section Xj+pj=O and this coefficient was equal to one. In this more general setting, it
depends on both attitudes towards risk and the relative importance of riskiess labour
income. Most important for our results is that this term is decreasing (increasing) in
wealth provided that Xj+f3jO). Suppose now that a country experiences a
positive output shock that raises investors' wealth. If the marginal unit of wealth is
invested in exactly the same proportions as the average unit, the overall risk
premium falls (rises) if kj+pj,O), and Equation (23) no longer holds. Hence,
for the arbitrage condition to be satisfied, the marginal unit of wealth invested in risky
domestic capital must exceed (be less than) the average unit.
This result qualifies the relationship between debt and the response of the
current account to output shocks. If X)j+,jO), a country may be a creditor
(debtor) and yet experience a current account deficit (surplus) in response to a
favourable income shock. If relative risk aversion decreases with wealth, positive
output shocks that raise wealth induce investors to take riskier investment positions.
As a result, the share of the marginal unit of wealth invested in risky domestic capital
exceeds its share in average wealth. Depending on the magnitude of this effect,
some creditor countries might run current account deficits. Since labour income is
less risky than capital income, positive output shocks raise the ratio of financial to
20 The coefficient of relative risk aversion of the value function tells us how the consumer
values different lotteries in wealth, as apposed to the coefficient of relative risk aversion of
the utility function, which tells us how the consumer values different lotteries over
consumption. The latter depends only on preferences, while the former depends on both
preferences and other aspects of the consumers' environment.
27
human wealth and hence expose the investor to greater risk. This induces investors
to take safer investment positions in their financial wealth, and so the share of the
shock invested in domestic capital falls short of its share in financial wealth. Hence,
some debtor countries might run current account surpluses in response to a
favourable output shock.
In summary, we find a simple rule to determine the response of the current
account to a favourable output shock. If the level of debt exceeds the following
threshold -fj > i Jp then favourable output shocks lead to a current account
deficit. Otherwise, they lead to a current account surplus. This threshold can be
positive or negative, and in the special case of the previous sections is equal to
zero. Finally, note that using Equation (21) we can rewrite this condition as nj>7C.
That is, high-output shocks lead to current account deficits in high-productivity
21~~~~~~~~~~~~~~~~~~~~~~~~~~2
countries and current account surpluses in low-productivity countries.2
21 Once again, remember that this is a consequence of our assumption that there are no
differences across countries in volatilities. See footnote 11.
28
4. Empirical Evidence
In this section, we present some preliminary empirical evidence that broadly
supports the theory developed above. This evidence is not intended as a formal test
of the theory, but rather as suggestive that we are capturing some aspects of the
behaviour of the current account in the real world. We begin by assuming that Xj+p3
and itj are unobservable. Hence, the threshold level of debt above which output
shocks lead to current account deficits cannot be observed. Under this assumption,
the content of our theory can be understood as a probabilistic statement that the
higher is the level of debt of the country, the more likely favourable output shocks
lead to current account deficits.22 We take per capita GNP growth as an imperfect
measure of the shocks emphasized by the theory. This measure is imperfect since it
does not distinguish between output and productivity shocks. Yet to the extent that
output shocks are present in the data, we would expect to find that the correlation of
the current account with per capita GNP growth is smaller in countries with higher
levels of debt. Accordingly, we study how this correlation varies with the level of debt
of a country.
Data
For our empirical work, we require appropriate measures of debt and the
current account. We construct a measure of debt using data on the international
investment positions (liPs) of OECD economies as reported in the International
Monetary Fund's Balance of Payments Statistics Yearbook. The IIP is a compilation
22 The unconditional probability of an output shock leading to a current account deficit is
Pr(kj+3j>-r-fj)=Pr(aj>i)=1/2. However, conditional on the level of debt of the country and for
any distribution of kj+pj, this probability is Pr(kj+Pj>-r-fjlfj) which is increasing in fj.
29
of estimates of stocks of assets corresponding to the various flow transactions in the
capital account of the balance of payments, valued at market prices. We measure
debt as minus one times the net holdings of public and private bonds, and other
long- and short-term capital of the resident official and non-official sectors,
expressed as a ratio to GNP. However, as noted in the introduction, this measure of
debt cannot be used to infer the share of wealth held as claims on domestic capital,
since it does not take into account the fact that the countries in our sample can hold
their wealth in three forms: debt, domestic capital, and capital located abroad.
Accordingly, we subtract outward foreign direct investment and holdings of foreign
equity by domestic residents from debt to arrive at an "adjusted debt" measure.
Figure Al plots the time series for debt and adjusted debt for the thirteen OECD
economies for which we are able to construct these variables.23 Table 1 presents an
overview of the data for the sample of 13 OECD countries for which it is possible to
construct adjusted debt measures. The first column reports the net external debt of
country j, expressed as a fraction of GNP, while the second column reports the
holdings of claims on capital located abroad. The third column reports the difference
between the first two columns, our "adjusted debt" measure.
We measure the current account as the change in the international
investment position of a country, expressed as a fraction of GNP. Since lIPs are
measured at market prices, the change in the IIP reflects both the within-period
transactions which comprise the conventional flow measure of the current account,
as well as revaluations in the stock of foreign assets. Figure A2, which plots the
conventional measure of the current account and the change in the IIP for each of
the countries in our sample, reveals that the contribution of revaluation effects to
the change in the IIP is substantial in most countries.
23 The final sample of countries is determined by the limited data availability for these series.
A complete description of the data is provided in Appendix 2.
30
Current Account Cyclicality in Debtor and Creditor Countries
We are now ready to examine how the cyclicality of the current account
vanes with the level of debt of a country. Table 2 presents a first look at the
evidence. The first column reports the average level of adjusted debt over the
period 1971-93, while the second column reports the time-series correlation of the
current account surplus (expressed as a share of GNP) with per capita GNP growth
over the same period, for each of the countries in our sample. In six out of seven
countries where adjusted debt is positive, the current account is countercyclical
(Sweden is the only exception), while in five out of six countries where adjusted debt
is negative, the current account is procyclical (Japan is the only exception). This
pattern is highlighted in Figure 1, which plots the cyclicality of the current account
(on the vertical axis) against the level of adjusted debt (on the horizontal axis).
There is a clear negative relationship, and the simple correlation between the two
variables is -0.54.
Although highly suggestive, the results in Table 1 should be interpreted with
some caution as they pool information within countries. To the extent that country-
specific levels of productivity are constant over time, this poses no particular
difficulties. However, if changes in productivity are important in the data, the simple
time series correlations in Figure 1 may obscure variations over time in the cyclicality
of the current account within countries. To address this concem, we adopt the
following strategy. First, we pool all country-year pairs of observations and rank
them by their adjusted debt. We then divide the sample in two at a particular
threshold level of adjusted debt. Then, for the two subsamples, we compute the
31
cyclicality of the current account for the two subgroups and test whether they are
significantly different.24
Figures 2(a)-2(d) present the results of this robustness check for various
subsamples of the data. In each figure, the bold (solid) line plots the cyclicality of the
current account in debtor (creditor) countries for the corresponding level of adjusted
debt at which the sample is divided in two, indicated on the x-axis. The dashed line
reports the p-value for a test of the null hypothesis that the cyclicality of the current
account is equal in the two groups. Figure 2(a) uses data for all countries over the
entire period from 1971 to 1993, and reveals that current accounts are clearly
procyclical in creditor countries and countercyclical in debtors. Moreover, for a wide
range of values of the threshold, this difference is significant at the 5-10 percent
level. Figures 2(b),(c) and (d) present the same information for three subsamples of
the data. Figures 2(b) and 2(c) restrict the sample to the 1971-81 and 1982-93
subperiods respectively, and reveal that the difference in current account cyclicality
is much more pronounced in the latter period. However, if we drop the two years
following the 1973 and 1979 oil shocks from the 1971-82 subperiod, as is done in
Figure 2(d), the pattern we emphasize re-emerges.
In the theory developed above, output shocks are saved in both debtor and
creditor countries, while the differential current account behavior in the two sets of
countries arises from the the differential investment response to output shocks. In
debtor countries, a fraction greater than one of these savings is allocated to
domestic capital, while in creditor countries a this fraction is smaller than one. The
24 We remove country means from all variables before computing the correlations. We test
for equality of current account cyclicality in the two groups as follows: First, we regress the
current account on per capita income growth in the two subsamples. Under the assumption
that the two point estimators are independent and asymptotically normal, we can construct
the usual Wald statistic for the null hypotheses that the slope coefficients are equal in the two
subsamples. A rejection of this null hypothesis constitutes evidence that the cyclicality of the
current account differs in the two groups of countries.
32
third and fourth columns of Table 2 provide some rough indicators of these two
pieces of the theory. The third column reports the within-country time-series
correlation between per capita GNP growth and savings. 25 In all countries, there is
a strong positive correlation between savings and per capita income growth at
annual frequencies, consistent with the view that at least some portion of shocks to
income are saved in order to smooth consumption over time. As in the theory, there
is no obvious relationship between the level of debt and the cyclical behaviour of
savings.26 The final column of Table 2 reports the within-country time series
correlation between savings and the current account. Consistent with the theory,
there is a strong negative relationship between the level of debt of a country and the
correlation of savings and the current account. In six out of seven debtor countries,
savings and the current account are negatively correlated, while in five out of six
creditors, they are positively correlated (Sweden and Japan again are exceptions).
Other Explanations for the Debtor/Creditor Distinction
A notable feature of business cycles in OECD economies is that they tend to
be highly correlated across countries.27 This observation suggests two possible
alternative explanations which might account for the difference in current account
cyclicality between debtor and creditor countries. First, OECD-wide economic
expansions tend to be associated with increases in interest rates. In fact, the time-
series correlation between OECD average per capita GNP growth and growth in the
six-month LIBOR is 0.55. Thus, it is possible that current accounts are
25 Savings is defined as net national savings, expressed as a fraction of GNP.
26 This of course does not rule out other explanations for the procyclicality of savings. For
example, if booms redistribute wealth from individuals with low savings propensities to
individuals with high savings propensities, savings would also be procyclical. However, as
long as individuals allocate their wealth using investment rules such as the ones discussed in
this paper, our effects would still arise.
27 See Costello (1993) and Kraay and Ventura (1997)
33
countercyclical in debtor countries only because domestic booms coincide with high
present and expected future debt service obligations.
Second, to the extent that countries hold claims on foreign capital, current
account fluctuations also reflect domestic and foreign residents' decisions on how
much capital to hold abroad. This too can potentially account for the
countercyclicality of current accounts in debtor countries. To see why, suppose that,
consistent with the notion that they are high-productivity countries, debtor countries
tend to invest less abroad than foreigners invest in them. Then, provided that all
investors allocate their marginal unit of wealth among assets in the same proportions
as their average wealth, favourable income shocks that are correlated across
countries will produce current account deficits in debtor countries simply because
foreigners purchase more claims on debtor country capital than residents of the
debtor country purchase abroad. In our sample, the outward investment of debtor
countries was on average 5.6% of GNP, while inward investment in these countries
was 9.8%. In creditor countries, the corresponding figures are 15.2% and 11.1%.
To adequately differentiate our theory from these altematives, we revisit the
evidence presented above, conditioning on global shocks such as changes in world
interest rates and foreign income. This is done in Table 3 and Figure 3, which report
the partial correlation between the current account surplus and domestic per capita
GNP growth, controlling for the growth rate of the 6-month LIBOR and the growth
rate of OECD per capita GNP excluding the country in question.28 Now the cross-
country correlation between the level of adjusted debt and the cyclicality of the
current account remains negative, and is equal to -0.55. Figure 4 reports the results
of dividing the full sample of countries into debtors and creditors at various threshold
28 A further concern might be that productivity shocks account for a larger share of
fluctuations in per capita GNP growth in debtor countries than in creditors. Although there are
no a priori reasons to believe in this asymmetry, it is possible that our results are driven by it.
We did experiment with controlling for various proxies for productivity shocks, and obtained
substantially similar results to those reported here.
34
levels of debt. The pattem which emerges is similar to that in Figure 2(a). However,
we can now only reject the null hypothesis that the cyclicality of the current account
is the same in debtor and creditor countries over a smaller range of threshold levels
of debt.
35
5. Concluding Remarks
Using a model with quite conventional ingredients, we have derived the novel
prediction that, if investors exhibit constant relative risk aversion and have no labour
income, favourable output shocks lead to current account deficits in debtor countries
and surpluses in creditor countries. Under these assumptions, the marginal unit of
wealth (the income shock) is distributed across assets in the same proportions as
the average one. Since by definition the share of a debtor country's wealth devoted
to domestic capital exceeds one, an increase in wealth (savings) results in a greater
increase in domestic capital (investment), leading to a deficit on the current account.
Conversely, in creditor countries the increase in wealth exceeds investment at home,
as a portion of this wealth increase is invested abroad. This produces a current
account surplus in creditor countries. We have also shown that, if investors' risk
aversion varies with wealth and in the presence of labour income, there is a simple
rule to determine when a positive output shock leads to a current account deficit: the
country's debt has to exceed a threshold that can be either positive or negative, and
is zero in the case of constant relative risk aversion and no labour income. We have
also provided some suggestive evidence from thirteen OECD countries that is
consistent with this prediction.
To make progress one must be willing to make assumptions, and we have
not been shy about doing so. Sovereign risk and foreign investment are two
important features of real economies that we have left unmodelled here. We feel
confident however that our results would survive all but the most extreme versions of
models that incorporate these elements. In our opinion, the most glaring omission of
this paper is the absence of adjustment costs to investment. In real economies
investment is not "bang-bang" as we have assumed here. Abstracting from
adjustment costs greatly simplifies the analysis, while permitting us to isolate the
36
main economic forces at work. The drawback however is that the effects of all these
forces are collapsed into a single instant, effectively precluding any meaningful
discussion of the dynamic aspects of the current account responses to shocks. We
are currently extending the theory to determine how sluggish investment responses
to shocks affect the results presented here and, hopefully, derive new results
regarding the dynamic aspects of the current account responses to both output and
productivity shocks.
37
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39
Appendix 1: Solution Details
Optimal Consumption and Portfolio Rules
Here we derive the soluton to the consumers problem in the model of
Section 3, and note that the solution to the corresponding problem in Section 1
obtains as the special case where Xj=pj=O. The representative consumer residing in
country j maximizes (15) subject to the budget constraint (16) and the (correct in
equilibrium) belief that r is constant and itj follows the dynamics in Equation (2).29
The Bellman equation for this problem is:
p V(aj xj)= max ln(cj +pj)+ V( - [((lEj -r).xj +r).ai +xj -cj]+
<9'X? Dai ~~~~~~~~~~~~(Al)
+ a V(a-,ij). 1X .a? .a2 ++.[V(aj 7i +9(j)) V(ai'i )
The first order-conditions of this problem are:
- -V(ap nj) = 0, (A2)
c-V(aj,,Kj) a2V(aj,,xj) 2
~~a1) *( - r) + aa2 CT v -xa, =O (A3)
29 If X1=Pj=0, the solution to this problem is correct even if the world economy is not in a
steady-state with a constant interest rate.
40
It can easily be verified that the following value function solves the Bellian
equation:
V(aj, ,) = p1 -In(aa + +) + g(j) (A4)
where g(j) does not depend on aj. Substituting the derivatives of the value function
into the first order conditions (A2) and (A3) yields Equations (17) and (18). These in
tum specialize to Equations (5) and (6) for the case of lj=fj=O.
The World Steady-State
Here we show that, if lim - *.j +,Bj = 0, there exists a steady-state in
J=1
which both the world average productivity and world growth rate are constants. Let H
be the set of countries with x,= x, and L be the set of countries with W, = X .
Remember that each group contains the same number of countries. Therefore, the
average wealth of countries in the two groups is a = lim -* a, and
a =lmim j .a, Also, define s = a.Using this notation, we can write the world
interest rate as r = s * i + (1 s) _ - 2.
Next we show that there exists a distribution of wealth s* at which ds=O. We
do so in four steps. First, we note that, except for the cases in which a = 0 or a = 0,
di da
the condition ds=O requires that da = d. Second, we note that Equation (19), the
41
1J
assumption that lim - *x + pj = O, and the fact that a fraction +-dt of countries
change regime each period, jointly imply that:
dia ={( + (1 - s) * -) +S sX + (1- s)- *X -0 _2p] a + (a-a dt+
(A5)
+ (s+(1ii- 2im 2 *a *doD,
da = {[(s*' ) +s_c+(1-s).7c_2 _p +i-aa dt+
(A6)
( 5+S 53* - Eim 2.Zai dwi
Third, we note that, conditional on the ass and given that the shocks dcoj are
independent across countries, a straighfforward application of the Law of Large
2 2
Numbers shows that lim - Ea1 * dc = lim-J .* ai * dco i = 0. Fourth, it follows that
jd-I ~~~~~id.
ds=O if and only if:
s.(1-s) [(1- 2s). ( -) +2-(-) +*(1-2*s) = (A7)
An analysis of this equation reveals that there exist a solution s*e(1/2, 1]. Hence,
taking this distribution of wealth as an initial condition, the world average productivity
and the world interest rate are constant. The reader can easily check that the world
growth rate is also constant.
42
Appendix 2: Data Sources
This paper uses data on intemational investment positions (lIPs) reported in
the Intemational Monetary Fund's Balance of Payments Statistics Yearbook (5th
Edition). Subject to availability, this source reports data on the stocks of various
assets held abroad by residents of a country, and the corresponding stocks of
domestic assets held by non-residents. These stocks of assets are valued at market
prices, and hence changes in these stocks reflect unrealized capital gains and
losses which are not captured in the usual flow measure of the current account.
In order to empirically implement our model, we need to distinguish between
three components of the IIP: claims on foreign capital held by the residents of a
country (outward equity claims), claims on domestic capital held by non-residents
of that country (inward equity claims), and net holdings of the intemational bond.
Outward equity claims are measured as outward foreign direct investment plus
residents' holdings of corporate equities abroad. Similarly, inward equity claims are
measured as inward FDI plus non-residents' holdings of domestic corporate equities.
Finally, net bond holdings are proxied by the non-reserves residual of the IIP, which
includes net public and private bond holdings and other long- and short-term capital.
Our sample of countries was determined both by data availability and
concems about data quality. We began with a sample of 20 OECD economies.30
We then checked the overall IIP series for these countries against that reported in
Rider (1994), which presents independent estimates of liPs based on extensive
research into national sources. For most countries, these two sources correspond
30 Greece, Ireland and Iceland were immediately dropped from the sample due to extremely
limited data coverage. The Balance of Payments Statistics Yearbook reports balance of
payments data for an aggregate of Belgium and Luxembourg only. This reduces the original
sample of 24 OECD economies by four.
43
quite closely. However, we were forced to drop Belgium/Luxembourg and New
Zealand due to major discrepancies between the two sources. Next, we excluded
Portugal and Switzerland since IIP data were available only for eight years for each
of these countries. Finally, we dropped Denmark, Norway, Turkey from the sample
since stock data on the subcomponents of the IIP we required were not available.31
This resulted in fairly complete series on the IIP and its components for 13 countries
between 1970 and 1993. The remaining missing values in the sample were
obtained by cumulating the corresponding flow items from the balance of payments
in order to obtain a balanced panel of 24 annual observations for each country and
series.32
The remaining data used in this paper (GNP and net national savings) are
drawn from the OECD's national accounts.
31 Stock data on equity holdings not available for Norway and Turkey. Stock data on FDI not
available Turkey.
3254 out of a total of 312 observations were obtained in this manner, all of them in the early
1970s.
44
Table 1- Debt and Adjusted Debt
(percent of GNP, average, 1970-1993)
Debt Outward Investment Adjusted Debt
(1) (2) (3)=(1)-(2)
Debtor Countries
Finland 24.3 3.2 21.1
Canada 26.0 13.3 12.7
Australia 16.6 6.6 10.0
Sweden 17.1 8.6 8.5
Austria 8.5 2.4 6.1
Italy 6.5 3.3 3.3
Spain 4.5 1.7 2.8
Creditor Countries
France 2.2 6.4 -4.2
Japan -3.2 3.5 -6.7
United States 3.2 11.1 -7.9
Germany -3.5 5.8 -9.3
United Kingdom 6.3 27.8 -21.5
Netherlands -0.6 36.3 -36.9
Debtor Average 14.8 5.6 9.2
Creditor Average 0.7 15.2 -14.4
Table 2 - Current Account Cyclicality in Debtors and Creditors
Adjusted Debt Correlalion of Current Account Correlation of Savings Correlation of Savings
(percent of GNP) with Per Capita GNP Growth with Per Capita GNP Growth with Current Account
Debtor Countries
Finland 21.1 -0.02 0.76 -0.07
Canada 12.7 -0.31 0.55 -0.12
Australia 10.0 -0.04 0.42 -0.03
Sweden 8.5 0.32 0.48 0.31
Austria 6.1 -0.07 0.58 -0.23
Italy 3.3 -0.34 0.50 -0.11
Spain 2.8 -0.27 0.56 -0.18
Creditor Countries
France -4.2 0.05 0.62 0.05
Japan -6.7 -0.17 0.24 -0.29
United States -7.9 0.25 0.28 0.54
Germany -9.3 0.19 0.50 0.01
United Kingdom -21.5 0.02 0.46 0.00
Netherlands -36.9 0.47 0.62 0.14
Debtor Average 9.2 -0.10 0.55 -0.06
Creditor Average -14.4 0.13 0.45 0.07
Correlation w/ Adjusted Debt -0.54 0.20 -0.26
Figure 1: Current Account Cyclicality in Debtors and Creditors
Correlation of Current
0.50 Account with Per Capita
. NLD Income Growth, 1971-93
0.40
*SWE
0.30*SW
\ ~~~~~*USA
~~~ ~~DEU 0.20.
0.10
Adjusted Debt
_ _ i - _ - 0.-i --*- "j'-'-'--''
I *~~~FIN
-40.0 -30.0 -20.0 -10.0 0 20.0 30.0
.4. Creditors -0.10 Debtors --- -
*JPN
-0.20
*ESP
-0.30 *CAN
.ITA
-0.40
Corr(Current Account Surplus,
Real Per Capita GNP Growth)
* I~~~~~~~~~~~~C Q U
U1 -l 01 0 0/1 -~ 01 N 1
-0.10
-0.09 '
-0.08
-0.07
-0.07
005 '.CD
-0.04
-0.03
'J -0.03 0
Cl)~ ~ ~ ~ ~ ~ ~ ~ ~~~~C
-o -0.0
.= -0.02 D_c
I .o2. ,';I
0.02 CD
-0.01
o 0.01
>0.070 _ 0
S CD-
o0.01 0L
oL 0.0
S 0.02: *
0.03
0.041 ~~. C . . .
0C,
0.04
0.04
0.04
0.05
0.06'
0.06
0.07
0.08
0.09
0.10
0 -0 0 0 0 0 0 0 0 0
P-Value for Wald Test that Cyclicality
is Equal in Debtors and Creditors
Figure 2(b) -- Cyclicality of Current Account
(1982-93)
0.4 0.7
0.3 "06
Creditors
0.2 .,0.5u
ur -a | #. .A
0.2I P-valuel 20.2:r.
0
I-L 0.1
0 0
u
a2-4
P-Value
o -0.1.. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0. 2
Debtors
-0.2 --- 0.1
-0.3 i ic1*-rt . rr*ri1 -.. I'I iIIiIIlIIi 0
00)0 CD - W WDC f l qt N N a E CM U) '0R CO0W I... W D CD(0 00
Threshold Value of Adjusted Debt
Corr(Current Account Surplus,
Real Per Capita GNP Growth)
o 0 0
-0.09 C
-0.085
-0.08 ......---.-
-0.057-
-0.06 Z :
-0.05 -
-0.045-
-0.04-
-0.03- 4
- 402- _ (
*~~~~~~~~~~~~~~~~~~~~~
- -0.024-
_ -0.023
w -0.02 -
> -0.02 ,,
0
,@0-~ .oi ,_
0. - ,
-0.02- .Ca.......
.0.01
0.0 - .
-0.041.(2
0 .04 _ t-) ^
0.05
0.05-,0> :t
0.016
0.01: .
_ ~~~~~~~~~~~~~~0
0.02 -
0.03-
0.03 -
0.04 CD
0.04-
0.04-
0.05:
0.06:
0.07:
0.10
o 0 0 0h (0 0 0 C0 0o
P-Value for Wald Test that Cyclicality
is Equal in Debtors and Creditors
Corr(Current Account Surplus,
Real Per Capita GNP Growth)
6 b~~~~~~~~~~~~~~0-
-0.10
.0.09I
-0.08
-0.07
.0.06 )
-0.05 ,
-0.04
-0.04 ',
.0.04- , .-nf
-0.03- ;t
-0.03 - (00
-0.02+ ,
. -0.02- "
0 01'. j**Q
B -0.02 - O
-0.01.
0.~~~~~~~~~~~
> -0.01 -D... (n
* 0.00- ,
tsua- 5 .*
~~~ 0.00+ ~ ~ ~ ~~~~C
CL0.01 CD c
0.02 r- C\
0.034- _i
0.03. 0
0.04 -
0.04~ >-
0.04 CD
00502
0.06
0.06
0.09 4
0.10
P-Value for Wald Test that Cyclicality
is Equal in Debtors and Creditors
Figure 3: Current Account Cyclicality Controlling for Global Shocks
Partial Correlation of Current Account
NLD 0.50 with Per Capita Income Growth,
N controlling for OECD Growth and
0.40 -Growth in LIBOR, 1971-93
0.30 -
~~~ DEU ~~~~~~0.20 t SWE.
DEU~~~~~~
GBR 0.10 ~ AUS
AUT Adjusted Debt
I I I | bt | | FIN
-40.0 -30.0 -20.0 -10.0 0 10.0 20.8 30.0
.4- Creditors -0.10 * Debtors
JPN*
FRA
-0.20
CAN
ESP
-0.30 --
9TA
-0.40 -
Partial Correlation of Current Account
with Per Capita GNP Growth
o 0 0
-0.10 -
-0.09 ........
-0.08
-0.07 .
-0.071
-0.06
-0.015
-S~~~~~~~~~~~~~~~~~ ! . !
-0.05~ .
0.004'
I ), , . g0
-0.04
30.04 - ,C
i-0 03' . I ;
; 0.03 ! 0
r 0 03 g t ' ;,> 4 >~~~~~~~~0
0.002 < ,
-0.02
-0.05,1,
0.06
00 0
> 0.01 =:
0 ~~~~~~~~~CD~~~
0.08:
0 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~
0.03
0.04 CD
0.04
0.05
0.06
0.07~~~~~~~~~~~~~~~~~~~~~~~~ .... ...
0.07
0 0 0 0 0 0 0 0 0
P-Value for Wald Test that Cyclicality.
is Equal in Debtors and Creditors
Figure Al: Debt and Adjusted Debt
Adjusled DebU/GNP
DebVGNP
1 1= 19s LfL F=='L=. 1~~~~.0 1e t1
~~~~~ tz~~~~~~~~~~P
*.~ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ . F** *C
el.el.Jo- H.W.dC .
go as
.: _ ..... .. ..___......._ .
Figure A2: Alternative Measures or the Current Account
- -x(Change In Internatifnal Inveslnienit Posilin)tGNP
(Convelkninal flaw Measure (a Cunrent Account SurlplusyGlIP
C *"- ~#Ft ed. e
.~~~~~~~~~~~~~~Il GM . , . 1.r\L - SSe4*
'-A G. F .0 . -t 1
em ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~~~~~~e
O,~~~~~~~~~~~~~~~~~~.
Ce.~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~~~~~~~~G
4.~~~~~~~~~~~~~~~~~~.
._ .................._____U..._.____
so-.lbst W."S
GOP*+*_ _1 .*.~A-** ?w4@_
I rT f: y t trefiW 'I V
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