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Sources of current account fluctuations in Taiwan: 1989–2015

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Abstract

In this paper, we use a small open economy model with nontradable goods and time-varying interest rates to investigate the sources of fluctuations in Taiwan’s current account. The correlation coefficient between the implied path of the current account generated from our model and the actual current account data exceeds 0.9, while tests of the cross-equation restrictions also support the model-implied present value relationship between the current account and other macroeconomic variables. We find the consumption smoothing channel, based on the discounted sum of the expected future net output growth, is the main channel for current account adjustment in Taiwan. Expected changes in the real effective exchange rate also account for much of the variation in the current account.

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Notes

  1. The present value model is uniformly rejected when using Canadian and UK data, with Kano (2009) shedding light on the findings in Gruber (2004) that habit formation plays a crucial role in explaining current account fluctuations when using Canada and the UK as illustrations.

  2. Chen (2017) employs a panel data set for 49 developed and developing countries over the period 1996 to 2011 and finds that undervaluing the exchange rate retards research and development (R&D) activity, particularly in developed countries.

  3. The conditions \(\theta <1\) and \(\xi <1\) imply that the respective means of the consumption and net output growth rates are lower than the mean world real interest rate. These are required to satisfy the boundedness of the expected present value terms of (8). For details, see Kano (2008).

  4. We follow Wang (2005) and specify the net foreign asset position at the end of 1986 (denoted as \(F_{0}\)) as the initial value and use the annual data of “Contributing to Increase or Decrease in Reserve Money - Foreign Assets” (denoted as \(\varDelta F_{t}\)) to construct \(F_{t}\), i.e., \(F_{t}=F_{0}+\sum _{s=1}^{t}\varDelta F_{s}\).

  5. Because quarterly data for the net foreign asset position are unavailable, we compute the value of f by dividing the annual average value of \(F_{t}\) by the annual average value of \(NO_{t}\).

  6. For the Newey–West estimation, a Bartlett kernel with a bandwidth of \(4 \times (T/100)^{2/9}\) was used.

  7. It is also worth noting that the signs of \(\beta _{\varDelta no}\) appear to be positive. This can be explained by the fact that our definition of net output \(NO_{t}\) is output less investment and government spending. However, over our sample period, the growth rate of investment in Taiwan is higher than the output growth rate, and this will cause the growth rate of net output to deviate from its long-run mean \(\varDelta \ln \widetilde{NO}_{t}\), such that it becomes temporarily negative and leads to a current account surplus.

  8. We also use the benchmark BIS real effective exchange rate to implement the subsample analysis. However, the results of the Wald test indicate the rejection of the model.

  9. Active official interventions can violate the assumptions of a small open economy model and the exogeneity of the exchange rate. Typically, market intervention affects the country’s nominal exchange rate for an implicit policy goal regarding the current account or trade balance. This endogenous response of the exchange rate induced by official interventions could generate bias in our inferences based on the cross-equation restrictions implied by the model. To resolve this endogeneity problem, we need to construct a fully fledged small open economy model in which we explicitly specify the market interventions of the monetary authority. However, this is beyond the scope of the present paper and we defer this to future research.

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Acknowledgements

We would like to thank Robert Kunst (Coordinating Editor), two anonymous reviewers and the seminar participants at WEAI 93rd Annual Conference for helpful comments and suggestions. This research was supported by a Grant from the Ministry of Science and Technology, R.O.C. (MOST-103-2410-H-030-006-MY2).

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Authors and Affiliations

  1. Department of Civic Education and Leadership, National Taiwan Normal University, No.162, Section 1, Heping East Road, Da-An District, Taipei, 106, Taiwan

    Yu-Hsi Chou

  2. Department of Economics, Fu-Jen Catholic University, No.510, Zhongzheng Road, Xinzhuang District, New Taipei City, 24205, Taiwan

    Chun-Yen Tsai

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Chou, YH., Tsai, CY. Sources of current account fluctuations in Taiwan: 1989–2015. Empir Econ 60, 2125–2151 (2021). https://doi.org/10.1007/s00181-020-01829-z

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