1. Rationale of the research Exchange rates play a crucial role in international trade and can have significant implications for a countrys current account. The current account is a component of a countrys balance of payments, which measures the inflows and outflows of goods, services, income, and transfers. It represents the net balance of a countrys trade in goods and services with the rest of the world, along with net income flows and transfers. Exchange rate fluctuations can affect the current account balance through various channels, including trade competitiveness, import and export volumes, and income flows. Recognizing the importance and significance of this issue, in our research paper entitled Analyze the effect of exchange rates on current account in OECD countries, our team will focus on analyzing the overall impacts of exchange rate on the current account balance in countries belonging to OECD and provide some potential policies and solutions.
FOREIGN TRADE UNIVERSITY FACULTY OF BANKING AND FINANCE *** INTERNATIONAL FINANCE ANALYZE THE EFFECT OF EXCHANGE RATES ON CURRENT ACCOUNTS IN OECD COUNTRIES Class: TCHE414 Lecturer: Assoc Prof., PhD Mai Thu Hien Name: Group Hanoi, June 2023 INTERNATIONAL FINANCE GROUP TABLE OF CONTENTS INTRODUCTION CHAPTER 1: LITERATURE REVIEW .6 CHAPTER 2: THEORETICAL FRAMEWORK 12 CHAPTER 3: RESEARCH MODEL AND RESULTS 16 3.1 Data description 16 3.1.1 Data collection and description .16 3.1.2 The statistical descriptions of the variables .16 3.1.3 Correlation description between the variables 17 3.2 Model specification .18 3.3 Estimation result 19 3.4 Discussion 20 CHAPTER 4: POLICY IMPLICATIONS 23 CONCLUSION .27 REFERRENCES 28 Page INTERNATIONAL FINANCE GROUP LIST OF TABLES Table 3-1: Variables and sources of data collected 16 Table 3-2: Descriptive Statistics of variables 16 Table 3-3: Correlation matrix 17 Table 3-4: FGLS estimation result 19 Page INTERNATIONAL FINANCE GROUP INTRODUCTION Rationale of the research Exchange rates play a crucial role in international trade and can have significant implications for a country's current account The current account is a component of a country's balance of payments, which measures the inflows and outflows of goods, services, income, and transfers It represents the net balance of a country's trade in goods and services with the rest of the world, along with net income flows and transfers Exchange rate fluctuations can affect the current account balance through various channels, including trade competitiveness, import and export volumes, and income flows Recognizing the importance and significance of this issue, in our research paper entitled "Analyze the effect of exchange rates on current account in OECD countries", our team will focus on analyzing the overall impacts of exchange rate on the current account balance in countries belonging to OECD and provide some potential policies and solutions Aims and Objectives of the research The study aims to investigate the relationship between exchange rates and the current account balances in these countries It seeks to understand how changes in exchange rates affect the current account, which is a key component of a country's balance of payments The research may analyze factors such as foreign direct investment, economic growth and other relevant economic indicators to assess the impact of exchange rate fluctuations on the current account position of OECD member countries The study could employ various econometric and statistical methods to analyze the data and draw meaningful conclusions about the effects of exchange rates on current accounts in the selected OECD members The purpose of this study is an attempt to provide valuable information for policymakers and society, and at the same time to open the discussion in one of the important topics in international finance Page INTERNATIONAL FINANCE GROUP Scope of the research The subject of the study is the link between exchange rate and current account in 38 countries in OECD The scope of the study focuses on the period from 2013 to 2021 in selected countries in OECD Research methods The research uses the following methods: Desk research method: This method is used to review research related to determinants of current account balance Specifically, the desk research method includes articles, articles published in scientific journals, summative reports, proceedings of scientific conferences, journals, and research papers on the given topic Qualitative approach by comparative analysis method to analyze and summarize the secondary data collected Quantitative approach by regression method: the research applied the Feasible Generalized Least Squares (FGLS) for panel data to identify the influence/impact of the explanatory factors on current account balance Structure of the research The structured study consists of five chapters: Chapter 1: Introduction Chapter 2: Literature review Chapter 3: Theoretical framework Chapter 4: Research model and results Chapter 5: Policy implications To complete the study, our team would like to thank Assoc Prof., PhD Mai Thu Hien for helping the team in the process of carrying out and completing the research Due to certain time and information constraints, as well as limitations on knowledge and skills, our team is looking forward to receiving comments, evaluations, and comments from the teacher so that the research paper will be more complete Page INTERNATIONAL FINANCE GROUP CHAPTER 1: LITERATURE REVIEW The literature on the determinants of the level and dynamics of the current account has been examined by a large number of studies during the past decades and it is an important issue for open economy macroeconomics There are different models with different predictions and choice of variables to understand which factors play a relevant role for current account dynamics In this section we provide a summary of the most important related research and empirical results, without providing a comprehensive overview “Determinants of Current Account Deficits in Developing Countries” by Cesar Augusto Calderon, Alberto Chong, and Norman V Loayza (2002) The study analyzes current account deficits in a sample of 44 developing countries from 1966 to 1994 The findings suggest that these deficits exhibit a moderate level of persistence beyond expected determinants, indicating a tendency for recurrent external deficits Domestic output growth increases the current account deficit, although high-growth countries not necessarily experience larger deficits Improved growth in industrialized countries reduces deficits in developing countries through increased export demand or shifts in investment patterns Public saving rates have a moderate impact in decreasing the current account deficit, while private saving rates show no significant effect Changes in balance of payments restrictions and foreign exchange rate restrictions not consistently reduce deficits Additionally, an appreciation of the real exchange rate, worsening terms of trade, and lower international real interest rates contribute to larger deficits The stages of development hypothesis finds support as countries with lower per capita GDP relative to industrialized countries tend to exhibit larger current account deficits Overall, these findings shed light on the complex dynamics of current account deficits in developing countries "The unsustainable US current account position revisited" by Maurice Obstfeld and Kenneth Rogoff Obstfeld and Rogoff argue that exchange rate misalignments can significantly impact a country's current account balance They discuss how sustained exchange rate undervaluation can lead to current account surpluses, while overvaluations can contribute Page INTERNATIONAL FINANCE GROUP to deficits The authors highlight the potential role of speculative bubbles and capital flows in driving misalignments The paper examines the sustainability of the US current account deficit by analyzing various factors that contribute to external imbalances Obstfeld and Rogoff discuss the implications of high net foreign liabilities and the interplay between current account deficits, budget deficits, and national saving rates The authors explore the mechanisms through which the current account deficit adjusts over time They discuss the role of exchange rate movements, price and income elasticities of imports and exports, and the adjustment process in response to shocks Obstfeld and Rogoff provide policy implications for addressing the US current account deficit and external imbalances more broadly They discuss the potential benefits of exchange rate adjustments, fiscal consolidation, and structural reforms to improve competitiveness and domestic saving rates Based on the result, we can see the paper by Obstfeld and Rogoff provides a comprehensive analysis of the role of exchange rates in the US current account deficit It offers insights into the causes and consequences of external imbalances, as well as potential policy measures to address these issues The authors' examination of exchange rate misalignments and their effects on the sustainability of the US current account deficit contributes to the broader understanding of the relationship between exchange rates and current accounts However, the study still has limitation The research may focus on the specific case of the US current account deficit, which may limit the generalizability of the findings to other countries or contexts Exchange rate effects on the current account can vary across countries due to differences in economic structures, policy frameworks, and external factors Calderon et al (1999) “Current account deficits in Africa: stylized facts and basic determinants” This is one of the first studies to focus on the determinants of the current account for developing countries The authors use a panel data set of 44 developing countries with annual data for the period 1966–1995 The results indicate that GDP growth has a positive impact on the current account deficit; foreign (industrial countries) GDP growth reduces the current account deficit; changes in private and public saving rates reduces the current Page INTERNATIONAL FINANCE GROUP account deficit for the panel estimation but this effect does not hold for the cross section Page INTERNATIONAL FINANCE GROUP analysis; a real exchange rate appreciation, terms of trade deterioration and lower international real interest rates all increase the current account deficit; and countries with per capita GDP close to the industrial average have lower current account deficits (stages of development hypothesis) Recent empirical studies examining the determinants of the current account for developing countries includes Calderon et al (2007) and they found that a real exchange rate appreciation and deterioration in the terms of trade are associated with a worse current account deficit Aristovnik, A (2006) “The determinants and excessiveness of current account deficits in Eastern Europe and the former Soviet Union” The article investigates the main factors of current account deficits in order to assess the potential excessiveness of current account deficits in selected countries of Eastern Europe and the former Soviet Union According to the simulated benchmark calculated on the basis of selected determinants (in period 1992-2003), the results confirm that the actual current account balances are generally close to their estimated levels in the 2000-2003 period in the transition region This notion is in line with the intertemporal approach to the current account balance, suggesting that higher external deficits are a natural outcome when permanent domestic output exceeds the current one and when current investments and government consumption exceed their permanent levels Hence, the results suggest that most countries in Eastern Europe and the former Soviet Union are justified in running relatively high current account deficits Aristovnik (2006) concludes that real exchange rate appreciation and worsening trade conditions increase the current account deficit The findings showed that countries with current account deficits that were higher than 5% of their GDP encountered problem with deficit sustainability Chinn, M., & Wei, S (2013) “A faith-based initiative: Does a flexible exchange rate regime really facilitate current account adjustment?” Journal of International Economics Page INTERNATIONAL FINANCE GROUP The authors employ an empirical approach to analyze the relationship between exchange rate flexibility and current account adjustment To conduct their analysis, Chinn and Wei employ a dataset covering 128 countries over the period from 1970 to 2007 They utilize several econometric techniques to examine the relationship between exchange rate flexibility and current account adjustment.They use a panel dataset of countries and employ various econometric techniques to estimate the effects of exchange rate flexibility on the current account Chinn and Wei define exchange rate flexibility as the degree to which a country allows its exchange rate to fluctuate freely in response to market forces They measure exchange rate flexibility using different indicators, such as the degree of exchange rate dispersion and the participation in exchange rate arrangements The paper focuses on how exchange rate flexibility affects current account adjustment Current account adjustment refers to the process by which countries' external imbalances, such as trade deficits or surpluses, are corrected over time The result is that greater exchange rate flexibility is associated with a smaller current account adjustment In other words, countries with more flexible exchange rate regimes tend to experience less significant changes in their current account balances The results suggest that flexible exchange rates may not necessarily facilitate rapid adjustments in the current account Chinn and Wei's study provides empirical evidence supporting the notion that a flexible exchange rate regime can facilitate current account adjustment Their findings suggest that exchange rate flexibility influences the price responsiveness of exports and imports, ultimately contributing to a more balanced current account However, it is important to consider the limitations of the study and recognize that the effects of exchange rate flexibility may be influenced by various country-specific factors “The impact of the exchange rate on the foreign trade imbalance during the economic crisis in the new EU member states and the Western Balkan countries” by Miloš Rajković, Predrag Bjelić, Danijela Jaćimović & Miroslav Verbič (2020) During the global economic crisis, the Western Balkan and Central and Eastern European countries faced trade imbalances as a major challenge for sustainable economic growth Page 10 INTERNATIONAL FINANCE GROUP 3.2 Model specification Suggested by Chinn, Prasad (2000), Calderon, Chong, Roayza (2002), Aristovnik (2006), Aristovnik (2007), Ozdama (2015), Rajković, et al (2020), the group of authors estimated the following model: 𝒄𝒂𝒊𝒕 = 𝜷𝟎 + 𝜷𝟏𝒓𝒆𝒆𝒓𝒊𝒕 + 𝜷𝟐𝒇𝒅𝒊𝒊𝒕 + 𝜷𝟑𝒈𝒓𝒐𝒘𝒕𝒉𝒊𝒕 + 𝒖𝒊𝒕 Where: 𝑐𝑎it: Current account balance of country i at time t (dependent variable) 𝑟𝑒𝑒𝑟it: Real effective exchange rate index (2010) of country i at time t (independent variable 1) 𝑓𝑑𝑖it : Net inflows FDI of country i at time t (independent variable 2) 𝑔𝑟𝑜𝑤𝑡ℎit : GDP growth of country i at time t (independent variable 3) The model is to be estimated by the FGLS model for panel data FGLS assumes the covariance of the error is unknown, and thus, uses the estimated covariance to estimate the generalized difference equation, or the GLS (Generalized Least Squares) model (Gujarati, 2008) Furthermore, as FGLS (and GLS) estimators are more efficient compared to OLS with regard to heteroskedasticity and autocorrelation, it is not necessary to check for the problem of heteroskedasticity and autocorrelation in the model Page 20