Dr. Roberto Duncan, Professor of Economics at Ohio University, published a guest column on “1997: The Relevant Threshold in the US Current Account” at Econbrowser on Feb. 24.
Dr. Roberto Duncan
In spite of the current account reversals observed in advanced countries, global imbalances are still a matter of concern (IMF, 2014). Probably, the US current account is the most important component of such worldwide imbalances. The size of the US external deficit has been an issue of analysis for many years. Research on this specific topic has used, at least, two approaches. On the one hand, some researchers contend that thresholds in the dynamics of the current accounts exist. The simplest threshold model can be understood as one where a threshold value is used to identify ranges of values where the behavior predicted by the model varies in some relevant way. For example, Clarida, et al. (2005) find two thresholds in the US current-account-to-GDP ratio. According to that, if the current account surplus is above 2.2% or below -2.2% of GDP, we should expect a reversal toward its long-run mean. Usually, these papers employ only the information contained in the time series of the current account itself (a univariate approach). On the other hand, a number of works based on dynamic stochastic general equilibrium (DSGE) models suggest that the US current account is driven by shocks of fiscal balance, productivity level, productivity volatility, or oil prices….
Main findings
First, in contrast to the univariate threshold models, time is the most important threshold variable. I find a robust time break –not previously documented in the literature– in the relationship between the current account and its main drivers in the third quarter of 1997. Our estimates stubbornly point to 1997.III as the time break even if I use a larger sample such as 1957.I-2012.I.
The time break found in 1997.III coincides with two events: the onset of the Asian financial crisis and the Taxpayer Relief Act of 1997. The former implied a recomposition of portfolios among international investors, including central banks, and the decision of sharp devaluations, the imposition of capital controls, and reserves buildup by monetary authorities. In addition, the Asian financial crisis is viewed as the onset of a sequence of international crises among emerging market economies. Other economies that faced similar crises were Russia (1998), Brazil (1998), Argentina (1999-2002), and Turkey (2001). All of them involved sharp devaluations, modification of the exchange rate regime, and the rise of foreign exchange reserves as a hedge against potential speculative attacks or another financial crisis. While the change in exchange rate policies to limit currency appreciations has led to some to talk about a revived Bretton Woods system (Dooley et al., 2003), the war chests of foreign reserves have, at least in part, led to an increasing purchase of US treasury bonds, which is usually linked to the so- called global saving glut hypothesis (Bernanke, 2005). The second factor that might have contributed to the structural change originated domestically. The Taxpayer Relief Act of 1997, enacted on August 5th, reduced several federal taxes, provided some tax exemptions, and extended tax credits. According to estimates posted by the NBER, the average marginal tax on long-term gains was reduced by almost 7%, from 25.6% to 18.7% in 1997, the largest cut since 1960.
Second, as opposed to what other authors contend, I did not find evidence on the importance of the size or the sign of the current account as threshold variables. The time line always dominates any potential threshold variable previously used or proposed by the empirical literature in terms of model fit. The other candidate variables not only fail to provide an adequate fit compared to the time line, but also they are highly sensitive to the sample, and did not provide either precise threshold or coefficient estimates, or statistics that could support a valid model in each regime.
Third, the most significant determinants of the US current account are total factor productivity, the real exchange rate, the fiscal surplus, and the volatility of productivity in both regimes (before and after 1997.III). As the paper shows, the most statistically significant shifts are related to the productivity level, the real exchange rate, and the real interest rate. In particular, productivity shocks became more important after 1997.
Read his entire column at Econbrowser.
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