The Connection between the Exchange Rate and the Balance of Payments Accounts in the Czech Republic: An Econometric Approach

Tomáš Urbanovský

doi:10.5817/FAI2017-1-4

The Connection between the Exchange Rate and the Balance of Payments Accounts in the Czech Republic: An Econometric Approach

Vol.8,No.1(2017)

Tomáš Urbanovský

https://doi.org/10.5817/FAI2017-1-4

PDF

Abstract

Relationships between the nominal exchange rate, the current account and the financial account of the balance of payments in the Czech Republic are investigated in this presented paper. The implemented cointegration analysis and vector error correction model suggest one pair of Granger causality. It has been discovered that change in the current account balance Granger-causes a change in financial account balance. This relationship has the nature of two-way Granger causality, which means that a reversed relationship holds as well. Other relationships implying Granger causality were not found. Error terms were significant only in regressions with both accounts as dependent variables, which imply that only these variables return to their long-term equilibria. Because an increase in financial account surplus leads to a decrease in current account surplus (or deepening the current account deficit), excessive liberalization of the Czech financial system can lead to a large capital inflow, jeopardizes current account sustainability and results in a currency crisis in the Czech economy.

Keywords:
exchange rate; balance of payments; cointegration; VECM

References

Akaike, H. (1974). A new look at the statistical model identification. IEEE Transactions on Automatic Control, 19(6), pp. 716–723. https://doi.org/10.1109/TAC.1974.1100705

Dickey, D. A. and Fuller, W. A. (1979). Distribution of estimators for time series regressions with a unit root. Journal of the American Statistical Association, 74, pp. 427-431.

Dolado, J., Jenkinson, T. and Sosvilla-Rivero, S. (1990). Cointegration and Unit Roots. Journal of Economic Surveys, 4(3), pp. 249-273. https://doi.org/10.1111/j.1467-6419.1990.tb00088.x

Dornbusch, R. and Fischer, S. (1980). Exchange Rates and the Current Account. The American Economic Review, 70(5), pp. 960-971.

Enders, W. (2010). Applied econometric time series (3rd ed.). Hoboken: Wiley.

Ersoy, I. (2011). The Causal Relationship between the Financial Account and the Current Account: The Case of Turkey. International Research Journal of Finance and Economics, 75, pp.187-193.

Faroque, A. and Veloce, W. (1990). Causality and Structure of Canada’s Balance of Payments. Empirical Economics, 15, pp. 267-283. https://doi.org/10.1007/BF02426969

Fry, M., Claessens, S., Burridge, P. and Blanchet, M-C. (1995). Foreign Direct Investment, Other Capital Flows and Current Account Deficit: What causes what? World Bank Policy Research Working Paper, no.1527.

Guerin, S. S. (2004). The relationship between capital flows and current account: volatility and causality. ECARES, Université Libre de Bruxelles.

Gyntelberg, J., Loretan, M. and Subhanij, T. (2015). Private information, capital flows, and exchange rates. Swiss National Bank: Working paper, no. 12.

Hannan, E. J. and Quinn, B. G. (1979). The Determination of the order of an autoregression. Journal of the Royal Statistical Society, Series B, 41, pp. 190–195.

Johansen, S. and Juselius, K. (1990). Maximum Likelihood Estimation and Inference on Cointegration - with Applications to the Demand for Money. Oxford Bulletin of Economics and Statistics, 52, pp. 169-210. https://doi.org/10.1111/j.1468-0084.1990.mp52002003.x

Kandil, M. (2009). Exchange Rate Fluctuations and the Balance of Payments: Channels of Interaction in Developing and Developed Countries. Journal of Economic Integration, 24(1), pp. 151-174. https://doi.org/10.11130/jei.2009.24.1.151

Kim, C.-H. and Kim, D. (2010). Do Capital Inflows cause Current Account Deficits? Applied Economics Letters, 18(5), pp. 497-500. https://doi.org/10.1080/13504851003724267

Larrain, M. (2003). Central bank intervention, the current account, and exchange rates. International Advances in Economic Research, 9(3), pp. 196-205. https://doi.org/10.1007/BF02295443

Lau, E. and Fu, N. (2011). Financial and current account interrelationship: An empirical test. Journal of Applied Economic Sciences, 6(1), p. 34-42.

Martin, F. E. (2016). Exchange rate regimes and current account adjustment: An empirical investigation. Journal of International Money and Finance, 65, pp. 69-93. https://doi.org/10.1016/j.jimonfin.2016.03.006

Mastroyiannis, A. (2012). Causality Relationships in the Structure of Portugal’s Balance of International Payments. International Journal of Business and Social Science, 3(15), pp. 54-61.

Oeking, A. and Zwick, L. (2005). On the Relation between Capital Flows and the Current Account. Ruhr Economic Papers #565.

Schwarz, G. E. (1978). Estimating the dimension of a model. Annals of Statistics, 6(2), pp. 461–464. https://doi.org/10.1214/aos/1176344136

Siourounis, G. (2003). Capital Flows and Exchange Rates: An Empirical Analysis. London Business School, IFA Working Paper, No. 400.

Tang, T. C. (2014). Fiscal Deficit, Trade Deficit, and Financial Account Deficit: Triple Deficits Hypothesis with the U.S. Experience. Monash University Malaysia: DISCUSSION PAPER, vol. 6.

Turan, T. (2015). Causal relationship between current account and financial account balance in selected CEE countries. Journal of Economics, 63(9), pp. 959-974.

Yan, H. and Yang, C. (2008). Foreign Capital Inflows and the Current Account Imbalance: Which Causality Direction? Journal of Economic Integration, 23(2), pp. 434-461. https://doi.org/10.11130/jei.2008.23.2.434

Yan, H.-D. (2005). Causal Relationship between the Current Account and Financial Account. International Advances in Economic Research, 11(2), pp. 149-162. https://doi.org/10.1007/s11294-005-3012-y