The 45°-rule revisited

Abstract

The purpose of this note is to update and reconsider the 45°-rule (or Thirlwall's law) by applying cointegration techniques to export equations based on national accounts data for 16 countries. The income demand elasticities derived on this basis are fairly close to those found earlier, whereas the relative price elasticities are much lower, with the Marshall-Lerner condition satisfied for only few of the 16 countries. More important to the validity of the 45°-rule is that the conditions for cointegration are not satisfied, suggesting that the equations are misspecified and that current external accounts are non-stationary. When analysing this issue further it appears that the reasons for the apparent breakdown of the 45°-rule can be traced to developments in the 1970s and 1980s when countries were exposed to major changes in their terms of trade and real effective exchange rates.