“Productivity Shocks, Budget Deficits and the Current Account”

Bussiere, Fratzscher, Muller

Discussion comments fromJohn Rogers, FRB

April 29, 2006

Findings

• Productivity shocks are an important determinant of OECD countries current account balances.

• Government budget balances are not important.

• Suggests there is little evidence of a “twin deficits” story to current account determination.

Related Literature

• Twin Deficits papersThe Salad Days:

1980s papers (Summers, Bernheim, Roubini, Evans);

Mostly skepticism more recently:VAR papers; DGE models (Normandin, Erceg et. al.);Cross-country estimation (Chinn-Prasad)

• Productivity papersGlick-Rogoff, Kollman, Nason-Rogers, Gregory-Head

• Bussiere, Fratzscher, Muller -- Extension of Glick-Rogoff-- Very well-written, a pleasure to read

Theory Section

• Glick-Rogoff (1995) model with a new wrinkle

• Motivates role for budget balance; mechanism not taken too seriously

• Add rule-of-thumb consumers to G-R

- -> gov’t budget balance empirically unimportant for CA

- -> Issler-Vahid (JME, 2001) use same mechanism more successfully(closed economy VECM as in KPSW)

- -> why no permanent vs. temporary (fiscal policy) distinction?

Ahmed (JME, 1986 and 1987), others

Data

• Annual, 1960 – 2003

• Two separate panels- G-7- 21 OECD countries

• Global, country-specific productivity – OECD measure – Solow residuals:(i) Form Solow residual for each country;(ii) Take (GDP) weighted average across countries;(iii) Country-specific is deviation from global avergage.

•

Regressions

• Similar to Glick-Rogoff (1995)

(1) ΔCA(t) = rCA(t−1) + λΔS(t) + γ1I(t−1) + γ2ΔAc(t) + γ3ΔAg(t)

(2) ΔI(t) = (β1 − 1) I(t−1) + β2ΔAc(t) + β3ΔAg(t)

-- S primary gov’t surplus (the wrinkle)-- Ac (Ag) country-specific and global productivity-- Panel estimates and country-by-country (G-7)

• Of interest:-- γ2 < 0 γ3 = 0 (standard implications; BFM confirm)-- λ important? (BFM: No)

Robustness

• Productivity computed with principal component analysis– Nice, but I’m not sure this identifies common world

productivity Provide details Relate to Gregory and Head (JME, 1999) [more below]

• Drop certain countries from the sample

• Cyclically adjusted fiscal balance vs. unadjusted

Why Aggregate the Data?

• Best answer may be comparability with GR.

• But using average productivity e.g., a large movement in any individual country raises the average even if all other countries productivity unchanged.

Suppose there is a country specific component to TFP. - If it is idiosyncratic white noise, aggregating will wash it out. - If ~ random walk and independent across the economies, aggregating fine. - If ~ ARMA(p,q) and correlated across economies, aggregating implies mismeasurement of aggregate TFP. (Literature on “common features”.)

Alternative: Common trend-common cycle model - Vahid and Engle (JAE, 1993), Engle and Issler (JME, 1995).- Test for number of permanent and transitory components in G-7 TFPs.- Use estimates to test response of G-7 CA and I to TFP shocks.- Method measures simultaneous productivity changes in all seven countries. - Fluctuations may be of any magnitude and still be entirely country-specific.- Common movements fundamentally different from cross-country averages.

Conjecture: common features exist in G-7 transitory country specific TFPs because G-7 output growth rates appear to share common features.

Suggested Alternative Approach• Follow Gregory and Head (JME, 1999)

- Dynamic factor model of Productivity, Investment and CA

Zjt = aZjWt + uZ

jt,

Ijt = aIjWt + bjuZ

jt+ uIjt

CAjt = aCAjWt + cZ

juZjt + cI

juIjt + uCA

jt

• Current account decomposed into four components: – world-wide component, W;– country-specific productivity (uZ) and investment (uI) fluctuations; – residual associated with fluctuations in neither productivity nor

investment.

• Results: – Country-specific productivity fluctuations little impact on CA

(consistent with GR)– Country-specific investment fluctuations of primary importance for

CA

Other Alternatives

• Chinn-Prasad (JIE, 2003)– Empirical determinants of “medium-horizon” CA

fluctuations– More satisfying econometrically than GR

regressions– Gov’t budget balance consistently positive and

significant

• Nason-Rogers (JMCB, 2002)– Emphasis on joint dynamics of Investment and CA– Use a collection of restrictions and several just-

identified VARs of I and CA– Focus on shocks

Conclusion

• BFM find no evidence for Twin Deficits story for CA determination.

• Suggestions:– (1) examine time-variation in estimates– (2) relate more to existing literature