Consumption smoothing, capital controls and the current account in Ghana

Abstract

Much of the empirical evidence on developing economies indicates that the basic intertemporal model of the current account fails to predict the dynamics of the actual current account series. This article argues that the model can predict the dynamics of the current account series if it is appropriately adjusted to reflect the nature of capital mobility and exchange rate policies in these countries. Using data on Ghana that span across capital control and liberalized regimes this article reports three finding. First, consistent with the existing empirical evidence, the basic model fails to predict the dynamics of the actual current account. Second, extending the basic model to capture variations in interest rates and exchange rates better explains the path of the actual current account balances only during the liberalized regime. Third, tests of asymmetric access to the international financial market indicate that economic agents in Ghana could not use the international financial market to smooth their consumption during the capital control regime. However, the liberalization program that reduced constraints on capital flows has enabled economic agents to use the international capital market to smooth consumption.

Notes

¹ Similar results were found for most of the developing countries they studied.

² There were some attempts to liberalize trade during the periods 1966–69 and 1971. However, capital control measures were still in place. Hence, in the empirical analysis, I treated the entire period prior to 1982 as capital control period.

³ See Campbell et al. (1997), pp. 306–307, for the properties of a random variable that is conditionally lognormal distributed.

⁴ Given the condition that the empirical implementation of the model was based on de-meaned variables, the preference parameter, a constant, is dropped from Equation (2.3).

⁵ The constant term at the end of the expression will drop out of the empirical model when I later de-mean all the variables including the consumption based interest rates.

⁶ Note that is less than unity.