Current account and relative prices: Are there any cointegration relationships in the presence of structural breaks in emerging economies?

Abstract

The aim of this study is to examine the long-run relationship between the current account and relative prices, such as terms of trade (TOT) and real exchange rate, for the emerging economies. These variables have been exposed to large fluctuations for more than two decades in all emerging economies; therefore, structural breaks have to be taken into account in all estimations. In this article, various methodological techniques have been used to examine this long-run relationship (with and without the structural breaks). Two important results have emerged, first; when the structural changes are excluded there is a strong evidence for long-run relationship between current account and relative prices. Second; when the structural breaks are included, variables are found to be stationary. Hence, depending on the stability of the variables, the validity of the cointegration relationship has been seriously questioned. This study illustrates that the test results proving non-stationary of the series and the presence of cointegration may be spurious if there is any possibility of instability.

Keywords:

• current account
• terms of trade
• panel cointegration
• structural breaks

JEL Classifications:

• F32
• F41

Notes

1. See Obstfeld (1996, Chapter 1) and Bouakez and Kano (2008, 264) for further discussion of the effects of real interest rate fluctuation on consumption and current account.

2. See for examples Beyer, Haug, and Dewald (2009), Bagnai (2006) and Daly and Siddiki (2008) where cointegration relationship between variables were applied to non-stationary variables according to conventional unit root tests without accomodation of structural breaks.

3. The results are not provided in the article for the purpose of space saving and available upon the request.