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“Productivity Shocks, Budget Deficits and the Current Account” Bussiere, Fratzscher, Muller Discussion comments from John 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 papers The 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 papers Glick-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 + uZjt, Ijt = aIjWt + bjuZjt+ uIjt CAjt = aCAjWt + cZjuZjt + cIjuIjt + uCAjt • 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 justidentified 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