Sustainability of the US Current Account Deficit: An Econometric Analysis of the Impact of Capital Inflow on Domestic Economy

Abstract

The purpose of this paper is to estimate, by using the recent econometric techniques of unit root testing and Johansen-Juselius cointegration technique (1990), the impact of foreign capital inflow on the volume and efficiency of domestic investment in the United States during the period, 1973–1999. A battery of diagnostic tests is employed to check the validity and robustness of the estimated results. Evidence suggests that capital inflows have had a significant positive effect on the volume of US investment, but the effect on the efficiency of investment has been minimal. These findings imply that, while achieving current account balance is important, it is equally important to sustain and augment the beneficial impact of capital inflow by creating a more conducive investment climate. Given our limited ability to influence current account balance, this seems to be a more pragmatic policy option for dealing with the US current account imbalance.

JEL classification codes:

• F21
• F41
• O51

Key words:

• current account
• capital inflow