A Var Analysis of the Current Account

Abstract

The objective of this paper is to characterize the interaction of the current account with its determinants using quarterly time series data for Japan, the United Kingdom and the United States from 1970 to 2005. The empirical work adopts a VAR (Vector Autoregressive) framework to capture the dynamic relationships among variables. The model contains the standard determinants of the current account accepted in the literature— average real GDP growth, terms of trade, the openness ratio and the government budget balance as a percentage of GDP. Impulse response functions and forecast error variance decompositions indicate that the mentioned macroeconomic variables explain the current account reasonably well and play an important role in current account adjustment process. Real GDP growth shocks create a negative and terms of trade shocks create a positive (confirming the HLM effect) adjustment to current account in all countries. On the other hand, while a shock to government balance brings about a positive response in the current account both in Japan and in the U.S., this shock does not bring about any significant response to the current account in the U.K