Are current account deficits really sustainable in the G-7 countries?

Whether or not a current account deficit is sustainable has important implications for policy. If the current account deficit of a nation is sustainable, then it implies that the government should have no incentive to default on its international debt. In this article, we examine whether or not the current account deficits of the G-7 countries can be characterized by a unit root process with regime switching. The econometric methodology allows us to distinguish periods that are associated with unsustainable outcomes from those in which the intertemporal national long-run budget constraint (LRBC) holds. Among the main results, it is found that the likelihood of the LRBC holding is high for Germany and Japan, and thus the current account deficits are most likely to be sustainable. It is, however, very likely that the LRBC will not hold for Canada, France, Italy, the UK or the US, thus signifying a red signal that the current account deficits observed during the period were probably not on a sustainable path.