1. Current Account Dynamics:
A SVAR Analysis When the
Structural Shocks are not
Orthogonal
César R. Sobrino- Universidad del Turabo
Email: sobrinoc1@suagm.edu
Ellis Heath- Valdosta State University
Email: ebheath@valdosta.edu

2. Motivation
• Using Canada and UK, Kano (2008)
analyzes the Intertemporal Current
Account Approach (ICA).
• For a small open economy:
• Current account is independent of global
shocks.
• Current account responds positively to a
positive country-specific temporary shock.
• Current account does not respond to
country-specific permanent shocks.

3. Motivation
• Three-variable SVAR with long run
restrictions. Blanchard & Quah (1989).
• Ex-ante global real interest rate, net
output growth and current account/net
output.
• Permanent shocks to those series are
the structural shocks.
• The variance-covariance matrix of
structural shocks is the identity
matrix.

4. Motivation
• Using a SVAR approach, his findings
fit predictions
• But, there two puzzles:
– Excessive response of the current
account to country-specific transitory
shock.
– Country-specific transitory shocks
dominate current account variations in
the short and long run, but they do no
play any role in net output growth
fluctuations.

5. Motivation
• No correlation assumptions might be
determining the Kano’s puzzles.
• Enders and Hurns (2007).
– SVAR with long-run restrictions and
structural shocks are correlated at
leads.
– Idiosyncratic shocks should be
correlated due to fiscal and monetary
policies.

6. Methodology
• Structural VAR

7. Methodology
• Variables
– rt: ex ante global interest rate.
– ∆lnNOt: Net output growth
– CA/NOt: either current account over net
output growth

8. VAR in reduced form
• Matrix of observed residuals

9. In this setup
• 9 unknowns:
– three elements of B(0)
– The variances of the structural shocks
– The covariances of structural shocks
• 7 equations
– 6 elements of variance-covariance
matrix of observed residuals.
– A long run restriction:

10. In this setup
• Just identified system ,assuming no
correlation between the global shock
and idiosyncratic shocks.
• Then, idiosyncratic shocks are
correlated at leads.
• Two schemes

11. Scheme I

12. Scheme II

13. Data
• IMF, quarterly 1971:1-2006:2 for Canada and
UK
– The ex-ante global interest rate is a weighted
average of the ex-ante real interest rate minus the
forecasted inflation in the G7 countries.
– The net output is the real GDP minus investment
minus government expenses minus stock variation.
– The current account is the real GNP minus
consumption minus investment minus government
expenses minus stock variation

14. ADF Test

15. Variances and correlations coefficients

16. Scheme I - Forecast-error variance
decomposition

17. Scheme II - Forecast-error variance
decomposition

18. Scheme I – Canada: Impulse-response
functions

19. Scheme I – UK: Impulse-response
functions

20. Scheme II – Canada: Impulse-response
functions

21. Scheme II – UK: Impulse-response
functions