Mariarosaria Comunale. Current Account and REER misalignments in Central Eastern EU Countries: an update using the Macroeconomic Balance approach

Current Account and REER misalignments in Central
Eastern EU Countries: an update using the
Macroeconomic Balance approach 1
Mariarosaria Comunale
Bank of Lithuania
30.03.2017 - Eesti Pank Seminar, Tallinn
1The conclusions expressed in this paper are those of the author and do not
necessarily represent the o¢ cial views of the Bank of Lithuania.
Mariarosaria Comunale (Bank of Lithuania) CA IN CEECs 30.03.2017 1 / 45

Motivation (1)
Question Why is an assessment of REERs and CAs important in the
new EU member states ?
CA imbalances = important factor for emergence of bubbles and the
transmission of …nancial crisis internationally (Ca’Zorzi et al, 2012)
and can also signal elevated macroeconomic and …nancial stresses
(Obstfeld, 2012);
Huge CA changes in CEECs in the last 20 years;
It is worth examining the CA norms (as equilibrium CAs), based on
the CA fundamentals, to judge the CA in a medium-run perspective
(vs ad-hoc procedures).
Investigating if the CA are close to the country-speci…c and
time-varying equilibrium values can help one determine the
future adjustment needs and possible trajectories of
fundamentals.

Motivation (1)
IMF, WEO Database, October 2016

Motivation (2)
REER = provides an assessment of a country’s external
competitiveness and key role in external adjustment process in an
integrated world (Lee et al, 2008);
In the context of EMU is relevant to interpret the competitiveness
di¤erentials across members having the same currency or in order to
determine the appropriate entry rate;
Di¤erent fundamentals and misalignments in this rate can in‡uence
the e¤ectiveness of the common policies and the integration process;
Di¤erent trends over time;
Which is the REER that allows the CA to go back to
equilibrium in the medium-run?

Motivation (2)
Eurostat, REER-CPI 37 partners, data March 2017

This paper
Aim of the paper:
Following the standard IMF CGER –> “Macroeconomic Balance” (MB)
approach as in Lee et al. (2008)
We conduct an assessment of the current account position …rstly
and than of price competitiveness (REERs) of the CEECs.
Equilibrium value of the CA = based on CA fundamentals
(included exchange rate regimes, foreign capital ‡ows and global
factors);

This paper
Aim of the paper:
Following the standard IMF CGER –> “Macroeconomic Balance” (MB)
approach as in Lee et al. (2008)
We conduct an assessment of the current account position …rstly
and than of price competitiveness (REERs) of the CEECs.
Equilibrium value of the CA = based on CA fundamentals
(included exchange rate regimes, foreign capital ‡ows and global
factors);
Equilibrium value of the REER (FEER) = as the rate which closes the
gap between equilibrium CA and the projected CA value in the
medium-long run (IMF WEO) = REER that allows the CA to go
back to equilibrium in the medium-run

This paper (2)
Contribution to the literature:
1 It considers speci…cally the CEECs as an overall group using data
1994-2012 (update ongoing) –> more precise estimations of the
coe¢ cients of the determinants and CA elasticities (for REER
misalignments) than in the IMF CGER case;
2 It uses an heterogeneous panel setup (both in the static and in
the dynamic model), which takes into account the di¤erences in
coe¢ cients among the EU members & it is corrected for Cross
Sectional Dependence (CSD);
3 We provide an analysis of the role of exchange rate regimes,
di¤erent types of foreign capital ‡ows and global factors as
determinants of the CA. FDIs are used to compute the
misalignments as in Medina et al. (2010);
4 The estimates –> more precise than IMF = taylored for CEECs!

Main …ndings
The estimated coe¢ cients are in line with the expectations;

Main …ndings
Some global factors like shocks in oil prices or in oil supply might
have played a role in worsening the CA balance of the CEECs;

Main …ndings
Having a pegged exchange rate regime (or being part of the euro
zone) a¤ects the CA positively;

Main …ndings
The REERs behave in line with the CA gaps, which show a clear
cyclical behaviour;

Main …ndings
cyclical behaviour;
When the FDIs are introduced as a determinant for these countries,
the misalignments are larger, in the boom periods (positive
misalignments); while the misalignments are smaller during the crisis
(negative misalignments).

Overview of the presentation
1 Literature review
2 Methodology: empirical methodology
3 Diagnostics and estimation strategy
4 Expected results
5 Our results
6 Conclusions and policy implications

Literature review
REER equilibrium values:
Maeso-Fernandez et al. (2002) - main ones are: BEER (based on
REER det: Comunale, 2015, 2017) and FEER (indirect comes from
CA determinants)
Macroeconomic balance (MB) approach/FEER:
CA determinants in MB: Isard and Faruqee (1998), Lee et al. (2008)
and Medina et al. (2010);
CA determinants in broad literature: Ca’Zorzi et al. (2012); Bussiere
et al. (2010); Chinn and Prasad (2003); Calderon et al. (2002).
CA elasticities (to compute eq. REER): Isard and Faruqee (1998),
Comunale and Hessel (2014);
Case studies:
Transition & CEE countries: Égert and Lahréche-Révil (2003);
Rahman (2008);
Latvia: Ajevskis et al. (2012, 2015);

Methodology: empirical methodology - STEPS
1) Estimating the coe¢ cients βs of fundamentals (X) of the CA:
CAi,t = β0
i Xi,t + γi dummyi,t + εi,t
Following the literature, the X are:
the relative …scal balance, the relative dependency ratio and the relative
population growth, the initial NFA, the oil balance, a relative income
measure (GDP per capita PPP over US), the relative real GDP per capita
growth and the net FDI ‡ows/GDP (Medina et al., 2010).
dummy: 1) for the crisis/post-crisis period 2008-2012; 2) for the pegged
regimes (de facto, time-varying).

Methodology: empirical methodology
2) Computing the CA norm (=equilibrium value for CA) we need the
XT +H values = values of the fundamentals 7 years ahead (for 2012 is
2019 and so backwards, H=7) including the variables in relative terms.
CAnormi,t = bβ
0
i XT +H
3) We have the CA misalignments as (CA norm - CA based on projected
values from IMF WEO) –> we want to bring back the CA to
equilibrium in the MEDIUM-RUN
CAmisi,t = CAnormi,t CAunderlyingi,T +H

4) Then, in order to have the REER misalignments we need a measure of
CA elasticity εCA.
εCA = (εX
X
GDP ) [(εM 1) M
GDP ]
where εX and are εM the elasticities respectively of exports X and imports
M (vis-á-vis the rest of the world) to the REER.
These values are taken from Comunale and Hessel (2014) and are
based on euro zone data in the period 1994-2012 (heterogeneous
panel ECM for X, M with regressors: REER, foreign demand and
…nancial cycles)
–> we believe they are better than the one used by IMF from Isard and
Faruqee (1998) which consider all the countries together (homogeneous
coe¤) and use old data.
–> next update: using elasticity based on CEECs only –> for the time
being in the euro area some CEECs are already represented

4) Then, in order to have the REER misalignments we need a measure of
CA elasticity εCA = di¤erence wrt IMF
Comunale and Hessel (2014) Isard, Lee, Geis (1998)
CA ELASTICITY CA ELASTICITY
2012 avg 2012 avg
Bulgaria 0.51 0.49 0.41 0.34
Croatia 0.35 0.38 0.18 0.17
Czech Republic 0.47 0.42 0.62 0.46
Estonia 0.56 0.59 0.54 0.46
Hungary 0.49 0.44 0.39 0.27
Latvia 0.57 0.48 0.55 0.37
Lithuania 0.58 0.51 0.35 0.29
Poland 0.29 0.27 0.29 0.23
Romania 0.33 0.33 0.27 0.23
Slovakia 0.58 0.55 0.66 0.54
Slovenia 0.50 0.43 0.56 0.43

5) Ultimately, the REER misalignments are given as the ratio of CA gap
and the elasticity of CA. The equilibrium REER (FEER) will be simply the
actual REER minus the REER misalignments.
REERmisi,t = CAmis
εCA
FEERi,t = REERi,t REERmisi,t
REERmisi,t = REERi,t FEERi,t

Data
Period from 1994–2012 at annual frequency for 11 EU new member
states (Croatia is included);

Data
Y= current account over GDP from IMF WEO;

Data
REER = Eurostat, CPI de‡ated, 37 partners;

Data
NFA = EWN update by Lane and Milesi-Ferretti (2007);

Data
Other regressors: IMF WEO, WB WDI and UNDESA (demographics);

Data
Other regressors: IMF WEO, WB WDI and UNDESA (demographics);
The …scal balance, old-age dependency ratio, population growth, real
GDP per capita growth and GDP per capita PPP (taken as the ratio
w.r.t. the US values) are used in relative terms with the same
time-varying weights applied for the REER (also in case of
projected values).

Diagnostics and estimation strategy (1)
1. STATIC SETUP
Presence of Unit Roots (Im-Pesaran-Shin (2003) test and CIPS test)
= some series are not-stationary (relative old-age dependency ratio,
…scal balance/GDP and real GDP per capita growth) (**)
Cross-sectional dependence (Pesaran (2004) test) = CSD
=) In case of stationarity and CSD in a static framework: FE or Pooled
OLS (with Driscoll-Kraay correction)
=) similar to IMF CGER, Medina et al. (2010) and Lee et al. (2008)
estimators but s.e. corrected for CSD –> comparison available.
(**) Given the presence of some non-stationary series and of cointegration (Pedroni
test): GM-FMOLS methodology have also been provided (ALTERNATIVE)

Diagnostics and estimation strategy (2)
2. DYNAMIC SETUP In our opinion adding a lagged value of the
explanatory variable in the study of the determinants of the variable itself
to be used for the norm, it would be not correct. However, this can add
some interesting features in the analysis.
As additional analysis: CCEMG, which deals with CSD in dynamic
panels and allows for heterogeneous coe¢ cients (Pesaran and Tosetti,
2011)–> we can also check for the role of global factors, linked to our
determinants

Expected results (1)
Initial NFA - depends
Countries with negative NFA are expected to improve the CA position to preserve
long-term solvency, so the sign should be negative (Lane and Milesi-Ferretti,
2004). On the other hand, highly indebted countries typically record negative
income ‡ows, which weigh negatively on the CA (Ca’Zorzi et al., 2012)
FDI/GDP < 0 [Medina et al., 2010]
FDIs are more stable investments and less prone to sudden stops. If FDIs are
directed to …nance the CA de…cits, this brings a declining in CA over time,
because this method of …nancing is less uncertain
Fiscal balance/GDP > 0
Surplus (de…cit) increases (decreases) savings, except. full Ricardian equivalence
= private savings fully o¤set changes in public savings = no link
Old-age dependency ratio and population growth < 0
Less savings in case of high % of old people or population growth

Expected results (2)
Oil balance – depends
Depends if importers or exporters. Importers: declining other imports =positive
(Medina et al., 2010). In the literature this variable is also used to proxy the
sensitivity of a country to changes in oil prices (Ca’Zorzi et al., 2012).
Relative output growth (real GDP per capita growth) < 0
Captures relative economic growth respect to the partners = stronger growth is
often linked with a decline in CA –because of higher potential, the country can
save less today
Relative income (GDP per capita PPP over US) > 0
As they approach the income level of advanced economies = convergence, CA
should improve
A crisis/post crisis dummy (common factor, years from 2008 to
2012) > 0
Macroeconomic crisis can decrease the availability of international …nancing and
increase temporarily the CA

Results (1) : baseline with FE and POLS (corrected for
CSD) - data until 2012

Results (2) : CA misalignments without/with FDIs

(*) CA norms 2012 vs. 2007

Results (2c) : factor analysis for the Baltic States -
2004-2007 ( "boom period")

Results (2c) : factor analysis for the Baltic States -
2008-2012 ( "crisis period")

Results (3) : REER misalignments without/with FDIs

Results (4) : determinants by using CCEMG (dynamic +
global factors)

Results (ext) : results with di¤erent ‡ows and more
demographics- data until 2014
From Comunale (2016) "A closer look at EU current accounts"

Results (ext) : results with di¤erent ‡ows and more
demographics- data until 2014
From Comunale (2016) "A closer look at EU current accounts"
(sub-groups in EU)

Conclusions and policy implications (1)

cyclical behaviour;

cyclical behaviour;
When the FDIs are introduced as a determinant for these countries,
the misalignments are larger, in the boom periods (positive
misalignments); while the misalignments are smaller during the crisis
(negative misalignments).

The main policy implication involves the future behaviour.
Are further actions to rebalance the CAs needed? A balanced CA
(as close to CA=0 as possible) 6= equilibrium CA (*) which also
changes over time
Are the REER and its components the right instruments or/and may
be the role of the …nancial cycle as important?
We have an analysis applying a closer interaction between the
misalignments in the CA, the REER and the cyclical components
(Comunale, 2017 ECB WP) –> here some results

Interaction between the misalignments in the CA, the
REER and the cycle
- Bayesian panel VAR: CAmis (as here), REERmis (BEER as Comunale,
2017 JIMF), …nancial cycle:

Interaction between the misalignments in the CA, the
REER and the cycle
- Dynamic factor model

NEXT STEPS/IDEAS
1 Extend the sample to 2015-6;

NEXT STEPS/IDEAS
2 Applying the framework of Comunale and Hessel (2014) to have the
actual trade elasticities for CEECs and for the considered period;

NEXT STEPS/IDEAS
3 Comparison with EBA/EBA-lite (on going - here some results);

NEXT STEPS/IDEAS
4 Comparison with candidate member state (on going - here some
results) - separated paper?

NEXT STEPS/IDEAS
4 Comparison with candidate member state (on going - here some
results) - separated paper?
5 Comparison for the REER, with the BEER approach with ‡ows (as in
Comunale, 2015, 2017) - separated paper?

3. Mine v. CGER v. EBA-lite for CA norms and gaps
My
coefficients
with Medina
My
coefficients
with 3 flows
My
coefficients
with Medina
My
coefficients
with 3 flows
andmy data
(upto 2012)
andmy data
(upto 2014)
andmy data
(upto 2012)
andmy data
(upto 2014)
Bulgaria Peg -3.4 -3.9 -5.5 (EBA 2016) -0.2 1.9 6.8 (EBA 2016)
Croatia Peg -3.4 -5.6 4.2 (EBA 2016) -1.4 4.7 3.7 (CGER 2015); -1.0 (EBA 2016)
Czech Rep Float -3.6 -6.2 ? -2.7 5.5 1.0 (CGER 2015); 2.0 (EBA 2016)
Estonia Peg 0.7 -1.3 -1.3 (CGER 2014); -4.1 (EBA 2016) 0.6 0.5 -0.1 (CGER 2014); 3.6 (EBA 2016)
Hungary Float -0.6 -0.3 ? 0.9 1.5 ?
Latvia Peg -3.8 -3.3 -4.8 (EBA 2016) -1.8 0.9 3.6 (EBA 2016)
Lithuania Peg -1.8 -4.2 -4.3 (EBA 2016) 0.0 1.8 2.3 (EBA 2016)
Poland Float -2.1 -6.8 ? 1.4 3.4 ?
Romania Float -1.4 -5.1 -4.1 (CGER 2015); -3.0 (EBA 2016) 1.9 1.5 -0.8 (CGER 2015); 2.0 (EBA 2016)
Slovakia Peg -1.2 -4.8 -2.6 (EBA 2015) -3.6 7.0 2.1 (EBA 2015)
Slovenia Peg -2.1 -3.4 -1.7 (CGER 2014); -1.4 (EBA 2016) -3.7 8.0 7.5 (CGER 2014); [7.5, 9.5] (EBA 2016)
CA GAP CA GAP CA GAP
Art IVREGIME Art IV
CA norm CA norm CA norm

Reserve slide (4) : EBA-lite (2016)
Main di¤erences with my approach:
- homogeneous coe¢ cients; no CSD; variables added without
theoretical/empirical framework (mine follows Ca Zorzi et al, 2012);
present values of CA (not projected).

- 150 countries, data 1995-2013, estimated by using two-stage
GMM, no FE.
- Di¤ wrt EBA (2013): Excluded: Reserve currency status; VIX/VXO
index; Public health spending. Included: Aid and remittances

4. Comparison w.r.t. EU candidates

5. Comparison FEER v. BEER misalignments
BEER (Comunale, 2017 JIMF) FEER

Thank you for your attention!
e-mail to: mariarosaria.comunale@gmail.com
mcomunale@lb.lt
website: https://sites.google.com/site/mariarosariacomunale/home

Reserve slide (1) : determinants by using GM-FMOLS

Reserve slide (2) : EBA (2013)

Reserve slide (3) : EBA (2013)

Main di¤erences with my approach:
- homogeneous coe¢ cients; no CSD; variables added without
theoretical/empirical framework (mine follows Ca Zorzi et al, 2012);
present values of CA (not projected).

- 150 countries, data 1995-2013, estimated by using two-stage
GMM, no FE.
- Di¤ wrt EBA (2013): Excluded: Reserve currency status; VIX/VXO
index; Public health spending. Included: Aid and remittances

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