Balance of payments and fiscal sustainability

Akhmadieva, Veronika (2020) Balance of payments and fiscal sustainability. PhD thesis, Birkbeck, University of London.

Abstract

This thesis focuses on sustainability of the balance of payments as well as government surplus and debt. Chapter 2 uses the standard model for exports and imports demand proposed by Khan(1974) and used by Haynes and Stone (1983) and many others. The income-trade relationship is first analysed using WTO and IMF data for 15 countries for 1970-2013. We estimate ARDL/ECM models and find evidence of strong short-run and long-run effect of income on trade. Focusing on the UK and US cases, for which longer trade data is available from ONS and BEA, we adopt the theoretical framework proposed in Boyd et al. (2001) and find that the Marshall-Lerner condition holds only for the UK. This raises the question of how the balance of payments adjusts. Chapter 3 examines adjustment directly using a reduced form autoregressive model of feedback for the balance of payments for a panel of 17 countries for 1870-2016. The data comes from the Jorda-Schularick-Taylor (JST) Macrohistory Database. The theoretical framework is based on the works by Bohn (1998, 2007) and Obstfeld and Rogoff (2002).Pooled estimates (allowing for cross-country fixed effects) for both, the balance of trade and current account models, suggest that both processes are stabilising. This provides strong evidence of the balance of payments sustainability. There appears to be roughly symmetric adjustment by imports and exports. When the data are disaggregated by country and sub-sample, the evidence is somewhat more mixed. Chapter 4 examines the government surplus (deficit) and debt, which raises similar sustainability issues to the balance of payments. Again a reduced form auto regressive specification and the JST data are used to analyse the sustainability of the public sector surplus and debt. Pooled estimates suggest that public surplus is stabilising on its own lagged values, however unlike the balance of payments, the adjustment is not symmetric but done mainly by revenue. However, when we consider heterogeneous estimates, the feedback from debt is mostly insignificant. It seems that the level of debt a government can maintain mostly depends on the credibility of the borrowing government. In addition, we find that there is stronger pressure to adjust on countries running current account (or public) deficits versus those running surpluses. Chapter 5 compares stand-alone European countries that have control over their interest rate and exchange rate, which are traditionally seen as main instruments of adjustment, with European Monetary Union members that do not. We investigate whether joining the euro caused structural changes to promote adjustment. We construct counterfactuals using both single equation models and a six equation vector autoregression with foreign exogenous variables. We find no major differences between the two groups, thus, other adjustment mechanisms than structural change must be at play. There is a conclusion that discusses the contribution that the use of long span heteroge-neous panels can make to the analysis of sustainability. This thesis was written before the pandemic associated with the coronavirus. The pandemic disrupted trade and prompted large increases in government debts and deficits. These events will have important implications for the analysis of balance of payments and fiscal sustainability. This topic, while not covered in this thesis, might be an area for future research.

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