Current Account Reversals Triggered by Large Exchange Rate Movements

Japan’s long-lasting current account surplus as well as Germany’s temporary surplus during the 1980s are the two largest current account surpluses the world has witnessed. Remarkably, net exports were rising in both countries despite the large overall appreciation of the Japanese yen and the considerable strength of the German mark. This paper shows that the real exchange rate still mattered for the export performance of these economies. It applies a Markov-switching time series model to the current accounts of both countries, in which the transition probabilities depend on the level of the real exchange rate. It finds that both countries’ current accounts, while overall rising, experienced several setbacks and subsequent recoveries, with clear turning-points. It further demonstrates that current account reversals were triggered by the real exchange rate appreciating, or depreciating, too strongly.