FINANCIAL FLOWS, DOMESTIC POLICIES AND THE CURRENT ACCOUNT BALANCE: EVIDENCE ACROSS DEVELOPED AND DEVELOPING COUNTRIES

The paper evaluates the effects of fluctuations in financial flows and domestic policies on the change in the current account balance over time using data for a group of developing and advanced countries. The current account balance could improve with respect to portfolio and FDI flows and high government spending that support capacity building. Alternatively, financial flows help sustain a wider current account deficit. Domestic policies, appreciation of the exchange rate and higher oil price improve the current account balance if compatible with higher exports and capacity building. Alternatively, domestic policies, higher oil price and exchange rate appreciation could fuel inflationary expectations with a negative effect on competitiveness and the current account balance. Correlation coefficients across advanced and developing countries determine dominant channels across country groups on the current account balance. Across advanced countries, trend real GDP growth decreases with higher anticipated monetary growth that deteriorates the current account balance. In contrast, anticipated exchange rate appreciation and shocks to government spending and monetary growth improve the current account balance and increase trend real growth across countries. Trend price inflation decreases with respect to capital flows and monetary growth that enhance capacity as well as with respect to exchange rate appreciation that improve the current account balance. Across developing countries, trend price inflation decreases with respect to monetary shocks and oil price shocks that improve the current account balance. However, trend price inflation increases with respect to shocks to government spending that trigger inflationary pressures, notwithstanding improvement in the current account balance.