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External Debts and Current Account Adjustments

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Levent Bulut ()

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Abstract

This paper empirically investigates the effect of net external debt holdings on the size of medium-term current account balances. It utilizes an approach where net external debt holdings behave like a “shadow interest rate” in affecting the current account imbalances. This paper has four major findings: First, in a simple accounting framework, net external debt holdings have a significant dampening effect on medium-term current account imbalances: an increase in the net external debt holdings by 10% of GDP improves medium-term current account balances by 1% of GDP. Second, net external debt holdings affect current account imbalances through their effect on domestic investment and government expenditures. Private consumption, on the other hand, isn't affected by net external debt holdings. Third, across the country groups, it is found that OECD countries differ from developing countries in current account adjustments as government expenditures deteriorate more in developing countries than in OECD countries across the sample period. And finally, net external debt holdings temper current account imbalances more during 1980s than 1990s.

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Paper provided by Department of Economics, Emory University (Atlanta) in its series Emory Economics with number 0716.

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Date of creation: Oct 2007
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Handle: RePEc:emo:wp2003:0716

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