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Are current accounts driven by cost competitiveness or asset prices? A synthetic model and an empirical test

Are current accounts driven by cost competitiveness or asset prices? A synthetic model and an empirical test

Guschanski, Alexander ORCID: 0000-0002-7818-8264 and Stockhammer, Engelbert (2020) Are current accounts driven by cost competitiveness or asset prices? A synthetic model and an empirical test. Cambridge Journal of Economics (Advance Access). ISSN 0309-166X (Print), 1464-3545 (Online) (In Press) (doi:https://doi.org/10.1093/cje/beaa013)

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Abstract

While current account imbalances have widened in recent decades, their causes are still debated. Trade-centred approaches highlight the role of cost competitiveness, in particular unit labour costs, and aggregate demand. In contrast, finance-centred approaches focus on gross financial flows, driven by expectations and the return on assets, that impact demand and the exchange rate. This paper, first, builds a simple model of the current account that provides a synthesis between the two approaches. Unit labour costs impact the current account via the real exchange rate and income distribution, while financial inflows drive up asset prices which leads to nominal appreciation and an increase in domestic demand. Second, we estimate a reduced form of this model for 28 OECD countries from 1972 to 2014, controlling for both trade- and finance-centred channels and a wide range of control variables. Our results indicate that finance-centred channels, via equity and residential property prices, drove current account divergence in the OECD, while unit labour costs were less important. They suggest that the effects of gross financial flows deserve more attention in theoretical and empirical models of the current account.

Item Type: Article
Uncontrolled Keywords: current account, financial flows, competitiveness, asset prices
Subjects: H Social Sciences > H Social Sciences (General)
Faculty / Department / Research Group: Faculty of Business
Faculty of Business > Department of International Business & Economics
Faculty of Business > Institute of Political Economy, Governance, Finance and Accountability (IPEGFA)
Last Modified: 30 Jun 2020 13:32
Selected for GREAT 2016: None
Selected for GREAT 2017: None
Selected for GREAT 2018: None
Selected for GREAT 2019: None
Selected for REF2021: None
URI: http://gala.gre.ac.uk/id/eprint/28228

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