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Current Account Sustainability in G7 and BRICS: Evidence from a Long Memory Model with Structural Breaks

Christophe André (), Tsangyao Chang (), Luis Gil-Alana () and Rangan Gupta ()

No 201705, Working Papers from University of Pretoria, Department of Economics

Abstract: In this paper, we extend the existing literature on the sustainability of current account deficits by examining the relevance of long memory and structural breaks in modelling the dynamics of current account to GDP ratios. Unlike standard unit root tests, which can only indicate whether a series is stationary or not by looking at 0 or 1 for the orders of integration and which have low power, especially in cases where the series is characterized by a fractional process, the long memory approach provides an exact measure of the degree of persistence. However, long memory models are known to overestimate the degree of persistence of the series in the presence of structural breaks, which are very likely in quarterly macroeconomic data covering a long period. Indeed, we show that regime changes do exist in both the mean and trend of the current account to GDP ratios. Thus, we test persistence allowing for both smooth and sharp breaks. Our methodology also allows us to include any number of sharp breaks, whereas standard unit root tests only permit either one or two breaks. Hence, our approach is more general and more robust to misspecifications caused by the omission of breaks than standard methods. To the best of our knowledge, this is the first paper testing for the sustainability of current account balances in the seven major advanced economies (G7) and the BRICS group of countries using long-memory models incorporating both smooth and sharp breaks.

Keywords: Current account; sustainability; long-memory; smooth and sharp breaks; G7; BRICS (search for similar items in EconPapers)
JEL-codes: C22 F32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2017-01
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