CURRENT ACCOUNTS IN THE EURO AREA: AN INTERTEMPORAL APPROACH. José Manuel Campa Angel Gavilán

Transcription

1 CIIF Working Paper WP no 651 Sepember, 2006 CURRENT ACCOUNTS IN THE EURO AREA: AN INTERTEMPORAL APPROACH José Manuel Campa Angel Gavilán IESE Business School Universiy of Navarra Avda. Pearson, Barcelona, Spain. Tel.: (+34) Fax: (+34) Camino del Cerro del Águila, 3 (Cra. de Casilla, km 5,180) Madrid, Spain. Tel.: (+34) Fax: (+34) Copyrigh 2006 IESE Business School. IESE Business School-Universiy of Navarra - 1

2 The CIIF, Inernaional Cener for Financial Research, is an inerdisciplinary cener wih an inernaional oulook and a focus on eaching and research in finance. I was creaed a he beginning of 1992 o channel he financial research ineress of a mulidisciplinary group of professors a IESE Business School and has esablished iself as a nucleus of sudy wihin he School s aciviies. Ten years on, our chief objecives remain he same: Find answers o he quesions ha confron he owners and managers of finance companies and he financial direcors of all kinds of companies in he performance of heir duies Develop new ools for financial managemen Sudy in deph he changes ha occur in he marke and heir effecs on he financial dimension of business aciviy All of hese aciviies are programmed and carried ou wih he suppor of our sponsoring companies. Apar from providing vial financial assisance, our sponsors also help o define he Cener s research projecs, ensuring heir pracical relevance. The companies in quesion, o which we reierae our hanks, are: Aena, A.T. Kearney, Caja Madrid, Fundación Ramón Areces, Grupo Endesa, Royal Bank of Scoland and Unión Fenosa. hp:// IESE Business School-Universiy of Navarra

3 CURRENT ACCOUNTS IN THE EURO AREA: AN INTERTEMPORAL APPROACH José Manuel Campa Angel Gavilán Absrac This paper uses an ineremporal model of he curren accoun o evaluae he flucuaions in curren accoun balances experienced by Euro area counries over he las hree decades. In he model curren accoun balances are used o smooh consumpion and hey are driven by expecaions abou fuure income and relaive prices. This simple model is no rejeced for six (Belgium, France, Ialy, Neherlands, Porugal, and Spain) of he en Euro area counries examined, alhough he model ends o underesimae heir curren accoun volailiy. The analysis also shows ha he relaive conribuions o curren accoun balances of fuure oupu and relaive prices differ across counries. Expecaions of fuure growh increased in all Souhern European counries a he creaion of he Euro bu hey had considerably diverged by While in Porugal hese expecaions are now below is hisorical mean, in Spain hey are a a hisorical high. Professor of Financial Managemen, Grupo Sanander Chair in Financial Insiuions, IESE Servicio de Esudios Banco de España Keywords: Curren accoun, euro, exernal deficis, economic inegraion. IESE Business School-Universiy of Navarra

4 CURRENT ACCOUNTS IN THE EURO AREA: AN INTERTEMPORAL APPROACH 1. Inroducion Over he las few years, he curren accoun in he Euro area, as a whole, has remained essenially balanced, wih small deficis and surpluses very rarely above 1% of GDP. This balance a he aggregae level hides he remarkably differen evoluion of he curren accoun balances across member counries. Greece, Porugal and Spain, ha presened almos balanced (or even in surplus) curren accouns around he middle of he 1990s, have experienced since hen almos coninuously increasing curren accoun deficis. In 2005, hese imbalances were around 7% of GDP in Greece, 9% in Porugal and 8% in Spain. In conras, Germany has moved almos monoonically from curren accoun deficis of abou 1% of is GDP in he las years of he 1990s o an exernal surplus above 4% in In a somehow similar process, Ausria, ha had been increasing is exernal deficis during he firs half of he 1990s (reaching a defici above 3% of is GDP in 1999), has revered ha rend afer he inroducion of he Euro and has reduced is deficis monoonically o reach a small surplus in Wheher hese paerns of adjusmen of curren accoun balances wihin he area are a sympom of he success of he Euro or a sign for concern is a he cenre of much conroversy oday. These paerns in he curren accoun can be seen, a leas parly, as a naural consequence of he creaion of he EMU and is implicaions in erms of a much higher degree of financial and economic inegraion among is member counries. In an open economy a counry s exernal balance is deermined by he inerplay beween he counry s expecaions of fuure income (relaive o hose of is rading parners) and he coss of he necessary borrowing or lending ha he counry has o engage in wih he purpose of smoohing is consumpion over ime. Counries wih higher expecaions of fuure income will borrow oday and run large curren accoun deficis, while counries wih lower expecaions of fuure income will run curren accoun surpluses. A higher degree of economic and financial inegraion exacerbaes hese paerns hrough wo mechanisms. Firs, i reduces he coss of borrowing and lending inernaionally. 2 And second, i induces compeiion across counries and fosers he eliminaion of inernal inefficiencies and hus growh, wha is especially relevan in low income counries which, in principle, have more inefficiency o eliminae. 1 Daa come from he OECD Economic Oulook. 2 This has been especially clear for EMU counries where currency risk has compleely disappeared in ineres rae spreads across counries and he growh in moneary and fixed income markes has been subsanial. IESE Business School-Universiy of Navarra

5 The EMU has followed, a leas parly, his exbook predicion abou he effecs on curren accoun balances of increased inegraion. Rich counries, like Germany, have been experiencing large and increasing exernal surpluses while poorer counries (like Spain, Greece or Porugal) has been experiencing large and increasing exernal deficis. Blanchard and Giavazzi (2002) provide more empirical evidence supporing his connecion beween inegraion and curren accoun. Namely, for differen ses of counries, hey find ha a higher degree of economic and financial inegraion is associaed wih more dispersion in he curren accoun balances across counries and wih a sronger posiive correlaion beween income and curren accoun balance. The exising evidence, however, does no provide any informaion abou he size of he curren accoun flucuaions ha he member counries should experience when adjusing o he new scenario. Thus, i is no clear wheher he observed flucuaions reflec a proper adjusmen by he counries or insead an over- or under-adjusmen. In his sense, if some counries have increased heir exernal indebedness based on over-opimisic expecaions abou is fuure growh or abou he posiive effecs ha inernaional inegraion would have on i (as poined ou by Gourinchas [2002]), hey should experience a painful adjusmen sooner or laer. The decrease in economic aciviy experienced in recen years by some of he counries wih large previous deficis, such as Porugal, seems o give suppor o he over-adjusmen hypohesis. The purpose of his paper is o answer he quesion of wheher curren accoun flucuaions in he Euro area are wihin wha should be considered reasonable or have surpassed he reasonable boundaries. A precise answer o his quesion requires a specific model o deermine wha such a reasonable benchmark for curren accoun balances should be and o wha exen exising curren accoun balances are deviaing from i. The curren paper uses a sandard ineremporal curren accoun model as such a benchmark. The model considers a small open economy where consumers smooh consumpion over ime (Campbell, 1987). Thus, opimal consumpion is based on he expecaions of fuure oupu and relaive prices, and curren accoun balances in every period are he difference beween opimal consumpion and ne oupu in ha period. The model considers ime-varying ineres raes and exchange raes (hrough he exisence of raded and no raded goods), a feaure which could be poenially imporan in he conex of he Euro area. This model is confroned wih he daa over he las hree decades for en Euro area member counries. The model canno be rejeced o fi he behavior of he curren accoun for six of hem: Belgium, France, Ialy, Neherlands, Porugal and Spain. The model is, however, rejeced for Ausria, Finland, Germany and Ireland. For hese counries, he ineremporal approach pursued in he paper is no a valid represenaion of he daa. For he six counries in which he model is no rejeced, he paper hen uses he model in hree dimensions. Firs, i compares he curren accoun predicions of he model wih he acual ones. On average, he curren accoun prediced by he model was only 60%, 80% and 77% of he acual curren accoun of Neherlands, Porugal and Spain, respecively, and i was abou 50% less volaile han he acual one. For France and Ialy, however, he model fied almos perfecly boh he level and he volailiy of he curren accoun flucuaions. Finally, he model overesimaed considerably boh he level and he volailiy of he curren accoun in Belgium. Second, he paper analyses he main deerminan for each counry, of he curren accoun prediced by he model. In he model, curren accoun deficis occur for a combinaion of (i) expecaions of higher fuure oupu relaive o curren oupu, and/or (ii) lower expeced 2 - IESE Business School-Universiy of Navarra

6 relaive prices in he fuure (eiher via lower real ineres raes or lower prices of raded goods relaive o no raded goods). The relaive conribuion of hese wo componens varies subsanially across counries. For France, Ialy and Neherlands curren accoun balances are primarily driven by changes in expeced fuure relaive prices. In conras, for Belgium, Porugal and Spain expeced changes in ne oupu are he primary driver of he curren accoun (60%, 85% and 58%, respecively). Third, his paper akes a quick look a he expecaions of fuure growh ha, according o he model, are behind each counry s exernal balance. This exercise poins o some ineresing facs. In he second half of he 1990s counries in souhern Europe (France, Ialy, Porugal and Spain) experienced increases in heir expecaions of fuure oupu. Afer a small correcion around 2001, hese expecaions sabilized for Ialy, coninued o decline for Porugal, and sared o increase again for France and Spain. A his poin Spanish expecaions of fuure oupu relaive o curren oupu are a heir highes value of he las hiry years. Assuming ha in he fuure he shares of invesmen and governmen expendiure o GDP remain a heir acual levels in Spain, hese expecaions would imply a growh in per capia GDP for he nex en years 20% higher han he hisorical average of he pas hree decades. The res of he paper is organized as follows. Secion 2 briefly repors some exising evidence on he connecion beween curren accoun balances and economic and financial inegraion, and some evidence suggesing he possibiliy of curren accoun over-adjusmen in Porugal. Then, secion 3 describes he ineremporal curren accoun model used in his paper and is esable implicaions. These implicaions are esed in secion 5 using he daa described in secion 4. For he counries in which he model can no be rejeced, secion 6 provides more deailed esimaion resuls and addiional implicaions of he model. Secion 7 discusses differen issues relaed o he validiy of he model and secion 8 concludes. 2. The impac of inernaional marke inegraion on exernal balances There has recenly been an increasing ineres in undersanding he process of curren accoun adjusmens. This ineres has been parly due o he increase in curren accoun deficis in some large economies, mainly he Unied Saes, coupled wih he ongoing ineres in large curren accoun reversals. Mos of his lieraure has focused on wo relaed quesions: he relaionship beween inernaional financial and economic inegraion and curren accoun balances, and he process and he deerminans associaed wih large curren accoun reversals. Blanchard and Giavazzi (2002) is one example of he lieraure sudying he firs quesion. They consider wo differen ime periods relaed o lower and higher degrees of economic inegraion ( and ) and show, for hree differen ses of counries (a subse of OECD counries, EU member counries and EMU member counries), ha a counry s average oupu per capia and is exernal balance relaive o GDP are posiively correlaed in boh periods. Under he sandard assumpion in neoclassical growh models ha low income counries have higher growh poenial han higher income counries, his evidence is consisen wih he consumpion smoohing hypohesis. More ineresingly, hey also show ha he absolue value of his correlaion increased from he earlier period o he laer one as i will be prediced by an increase in economic inegraion. IESE Business School-Universiy of Navarra - 3

7 Figure 1 shows, ha his resul also holds rue for he subsample of Euro area member counries when more recen years are included. 3 The op figure shows he relaionship beween GDP per capia and cumulaive curren accoun balances for he period for he Euro area counries. The boom char shows he same relaionship for he following decade , which includes he impac of he creaion of he Euro. In boh cases, a posiive relaionship exiss beween GDP per capia and curren accoun balances. This relaionship is also more pronounced in he second period, wih he Euro, han in he firs period. An increase in economic inegraion also implies ha counries will be able o suppor larger exernal deficis relaive o heir GDPs. Blanchard and Giavazzi (2002) show ha, consisen wih his implicaion, he sandard deviaion of he curren accoun balances relaive o GDP across he counries in heir hree differen ses of counries increased almos monoonically over he period in which inernaional economic inegraion also increased. As illusraed in Figure 2, his resul also holds rue afer adding more recen years o he analysis. Despie a small decrease around 2000, he dispersion of curren accoun balances has broadly increased over ime following he increase in inernaional inegraion. Adale and Eichengreen (2005) documen a similar evidence. In paricular, hey repor ha he average curren accoun balances in absolue value have been larger during hisorical periods of high capial mobiliy (Gold Sandard [ ], 3.7% of GDP, he firs par of he inerwar period [ ], 3.9%, and he laer par of he las cenury [ ], 4.8%) han during periods of lower capial mobiliy (he Grea Depression and he period , prior o he breakdown of Breon Woods, in boh cases below 2%). The second line of he research has been focused on how large curren accoun imbalances ge reversed. For indusrial counries, he exising evidence indicaes ha curren accoun reversals end o occur around 5 percen of GDP, and involve a depreciaion of he currency and a decrease in GDP growh (Freund and Warnock (2005), Debelle and Galai (2005) and IMF (2002)). Freund and Warnock (2005) also repor ha he depreciaions associaed o curren accoun reversals are larger when he previous curren accoun deficis have coincided wih a surge in consumpion raher han in invesmen. I is no clear, however, ha he previous evidence is direcly applicable o he EMU member counries. In shor, none of he curren accoun reversals analyzed in he previous sudies were suffered by a counry belonging o a moneary union. This is relevan because he adjusmen mechanisms are clearly limied for hese counries. In paricular, nominal exchange rae adjusmen is no possible wihin a currency union and real exchange rae depreciaion mus come hrough inflaion differenials. An excepion o his commen is Edwards (2006), ha provides some evidence on he likelihood of a curren accoun reversal wihin a moneary union. He finds ha belonging o a currency union does no lower he probabiliy of facing a curren accoun reversal or a sudden sop in foreign capial inflows. One imporan limiaion of his evidence is ha i refers mainly o very small counries and i is no clear ha is conclusions are readily applicable o he EMU member counries. More relevan evidence on curren adjusmens in he Euro area is now coming from Porugal. As menioned in he Inroducion, Porugal experienced in he second half of he 1990s large and persisen exernal deficis. These large deficis occurred joinly wih increases in consumpion and governmen spending ha, coupled wih a lack of produciviy improvemens, 3 The same is rue for he ses of OECD counries and EU member counries considered in Blanchard and Giavazzi (2002). 4 - IESE Business School-Universiy of Navarra

8 made Poruguese inflaion larger han he Euro area average. Low produciviy growh and poor performance of heir raded goods secor hen led Porugal o a decrease in fuure growh expecaions. As a consequence, Porugal is currenly suffering a period of very low GDP growh (i grew a an average rae of 0.6% per year during he period ), increasing unemploymen (unemploymen increased by 85.4% in he same period) while sill mainaining large curren accoun deficis (in average accouning for 7.53% of GDP). 4 The case of Spain also deserves some aenion. In 2005, he curren accoun defici reached an all ime high around 8% of GDP. A he same ime, produciviy growh in Spain is one of he lowes in he EMU. According o he OECD Produciviy Index, Spanish produciviy has only improved by 2.1% over he period A very poor performance compared o he 3.7% of he EMU average, bu even worse if compared o some of he very good performers like Greece (22.3%) or Ireland (17.3%). In addiion, during he same period, Spanish growh in nominal wages and uni labor coss has almos doubled ha of he EMU (around 20% for Spain vs. around 10% for he EMU) and average annual inflaion rae for Spain is 3.1% (2.1% in he EMU). As a consequence, Spanish real exchange rae has appreciaed subsanially (beween 10% and 30% depending on he measure). 3. An ineremporal model of he curren accoun As menioned above, he main goal of his paper is o deermine a benchmark scenario for he behavior of he curren accoun ha can be compared wih he evoluion of he curren accoun balances in he daa. For ha purpose, we consider he model developed in Bergin and Sheffrin (2000) ha belongs o he class of ineremporal curren accoun (ICA) models. These models, firs inroduced by Sachs (1981), have been exensively used in he lieraure and basically consiue an exension of he permanen income hypohesis model o a small open economy. 5 The underlying deerminan of a counry s curren accoun in hese models is heir ciizens desire o smooh consumpion over ime. The mos salien feaure of he model developed in Bergin and Sheffrin (2000) is ha i allows simulaneously for ime-varying ineres raes and exchanges raes. They show ha he inclusion of hese feaures improves he radiionally poor empirical fi of simpler ICA models ha, eiher do no incorporae exchange raes, or impose consan ineres raes. This feaure is also especially relevan for he analysis of curren accoun flucuaions in he Euro area counries. The Euro has played an obvious role in fixing nominal exchange raes among member counries bu i has also caused a significan change in he average level of ineres raes in many of he member counries. These changes in ineres raes and exchange raes are likely o have affeced he evoluion of he curren accoun and, herefore, ough o be modelled explicily. The model considers a small open economy ha can borrow and lend wih he res of he world a a ime-varying real ineres rae. There are wo goods: raded and no raded goods. Consumpion and borrowing decisions in he small open economy are aken by a represenaive 4 See Blanchard (2006) for a more deailed descripion of he curren Poruguese siuaion. 5 Some examples are Sheffrin and Woo (1990), Oo (1992), Glick and Rogoff (1995), Ghosh (1995), Iscan (2002), Gruber (2004) and Nason and Rogers (2006). IESE Business School-Universiy of Navarra - 5

9 household who maximizes is discouned life ime uiliy solving he following ineremporal maximizaion problem: max s.. Y E 0 β = 0 ( C T U ( C + P C T N, C N ) I ) G + r B 1 = B B 1 (1) where C and C denoes consumpion by he household in raded and no raded goods, P is T N he price of no raded goods in erms of raded goods, Y denoes he value of curren oupu, I is invesmen expendiure, G is governmen expendiure, B is he sock of foreign asses a he beginning of he period, and r is he ne world real ineres rae he counry faces in erms of raded goods. 6 Moreover, assume ha per period uiliy funcion akes he following Cobb- Douglas form: U ( C T, C N 1 ) = ( C 1 σ a T C 1 a N ) 1 σ Where a (0,1) is, in equilibrium, he share of consumpion of raded goods in oal consumpion and σ>0 is he inverse of he ineremporal elasiciy of subsiuion. The Euler equaion for his maximizaion problem can be wrien as: 7 where ( 1 a )( γ 1) γ γ C P 1 = E ( + ) β 1 r + 1 (2) C + 1 P + 1 C = C + P C denoes oal consumpion expendiure in erms of raded goods and T N 1 γ = is he ineremporal elasiciy of subsiuion. Under cerain condiions, Bergin and σ Sheffrin (2000) show ha (2) can be wrien in a more racable form as: 8 E c γ (3) = + 1 Er +1 where c = log C 1 γ + 1 logc, r (1 ) = r + a p + consan γ and p = log P + 1 log P. Bergin and Sheffrin (2000) named r he consumpion-based real ineres rae and we will use he same erminology here for simpliciy. Basically, i is a weighed measure of relaive prices, r and P. 9 Equaion (3) esablishes he way in which relaive prices affec he opimal consumpion profile. In his model consumpion change is no a zero-mean random-walk, a common feaure of 6 In his model, oupu, invesmen and governmen expendiure are exogenous. 7 See Bergin and Sheffrin (2000) for he exac derivaion. 8 In paricular, hey assume join log normaliy for he gross real world ineres rae, he consumpion growh rae and he percen change in he relaive price of no raded goods, and ha he variances and co variances beween hese variables are ime invarian. 9 The fac ha r is defined up o a consan will no be a problem for he empirical analysis below since all he relevan variables will be demeaned. 6 - IESE Business School-Universiy of Navarra

10 many oher models in his lieraure. Insead, expeced changes in consumpion are a funcion of he expeced consumpion-based real ineres rae. Bergin and Sheffrin (2000) highligh he roles ha he ineres rae and he exchange rae have in he opimal consumpion profile: 10 An increase in he real ineres rae, r, makes curren consumpion more expensive relaive o fuure consumpion and induces subsiuion oward fuure consumpion wih elasiciyγ. The exchange rae plays a similar role hrough he ne impac of an inraemporal and an ineremporal effec. A change in he exchange rae induces an inraemporal subsiuion effec on consumpion. When he price of raded goods is emporarily low households subsiue raded goods for no raded goods in consumpion. Given ha he inraemporal rae of subsiuion is one (Cobb-Douglas), his raises he curren consumpion expendiure by (1-a). The ineremporal effec is driven by he relaive price of fuure vs. curren consumpion in erms of he prices of raded goods. When he price of raded goods is emporarily high and expeced o decrease, he fuure paymen of a loan in erms of raded goods is high and also expeced o decrease. This implies ha his fuure repaymen has a lower cos in erms of he full consumpion bundle han in erms of raded goods alone. Thus r rises and lowers he oal consumpion expendiure by he elasiciy γ ( 1 a). As long as γ <1, he ineremporal effec will dominae. To conclude he soluion of he maximizaion problem (1) one sill needs o combine (3) wih he ineremporal budge consrain of he problem. This is can be wrien as: = 0 0 ( RC ) = E0 ( R NO ) = 0 E + B (4) 0 where NO = Y I G denoes he ne oupu per period, R = ( 1+ rj ) j= 1 1 is he marke discoun rae for dae consumpion, and he ransversal condiion lim E 0 R B = is assumed o be saisfied. Again, as for he Euler equaion, Bergin and ( ) 0 Sheffrin (2000) consider a more racable expression for his ineremporal budge consrain and log-linearize (4) around he seady sae in which B = 0 (ha is, around he seady sae where ne foreign asses are 0). 11 By doing his, hey ge ha: = 1 [ no c ] = no0 c0 β (5) where no = log NO + 1 log NO, no 0 = log NO0 and c 0 = logc0. 10 Following Rogoff (1992) and Bergin and Sheffrin (2000) we will use he real exchange rae as a proxy for P. This is how we obain implicaions from he model in erms of he exchange rae. 11 A his poin, hey use he echniques in Campbell and Mankiw (1989) and Huang and Lin (1993). IESE Business School-Universiy of Navarra - 7

11 Taking expecaions in (5) and combining i wih (3) one can hen ge ha: = [ no r ] CA β (6) i E + i γ + 1 = i 1 afer defining CA no c. 12 Equaion (6) is he more relevan equaion of he model and i clearly illusraes he consumpion smoohing characer of he curren accoun. On he one hand, ceeris paribus, he curren accoun falls when ne oupu is expeced o raise as he represenaive consumer smoohes is consumpion. On he oher hand, ceeris paribus, he curren accoun also falls if he consumpion-based real ineres rae is expeced o decrease. The represenaive consumer subsiues away fuure consumpion for curren consumpion ha increases over is smoohed level Tesable implicaions of he model Empirical applicaions of ineremporal curren accoun models in he lieraure have radiionally exended, o a small open economy, he ess for he permanen income hypohesis model developed by Campbell (1987) and Campbell and Shiller (1987). 13 We will follow his approach here oo. 14 The model oulined above has several esable implicaions. Firs, equaion (6) implies ha CA should Granger cause no and r bu no he oher way around. Tha is, CA should have incremenal explanaory power for fuure values of no and r. This can be esed empirically. A second implicaion of he model ha can be esed empirically is provided by equaion (3), E = c+ 1 γ Er +1. I is possible o show analyically ha esing equaion (3) is equivalen o esing E ( R Ι 1 ) = 0 where R CA no γ r ( 1/ β ) CA 1. Tha is, he difference beween he forecas and he acual curren accoun is unpredicable, given he relevan informaion se. We will call his es he R-es. There is a hird approach for esing he model if one is willing o make specific assumpions abou how individuals form heir expecaions. This is he approach pursued, for insance, by Sheffrin and Woo (1990). Consider ha he behavior of he hree variables of ineres, no, CA and r can be modelled according o an unresriced auoregressive process of order 1, VAR(1), of he following shape: In he per period budge consrain in (1) inuiively one could defineca = B B = NO C. The definiion 1 of CA in (6) has he same idea bu wih he variables expressed in log erms. This measure of he curren accoun is approximaely he raio of he rade balance o consumpion in he economy. 13 See, for insance, Sheffrin and Woo (1990), Oo (1992), Ghosh (1995), Iscan (2002), Gruber (2004) and Nason and Rogers (2006). 14 Glick and Rogoff (1995) and Gruber (2002) consider ha Invesmen is endogenous and follow a differen empirical approach. 15 This can be easy generalized for higher order VARs. 8 - IESE Business School-Universiy of Navarra

12 z no CA r a = a a a a a a a a no CA r 1 u + u u (7) where u is a hree dimensional vecor of mean zero, homoskedasic errors. i Equaion (7) implies ha E ( z+ i ) A z and provides an empirical esimae of he expeced fuure values of hese variables a every horizon. CA is included in (7) because according o he model, as menioned above, CA should have incremenal explanaory power for fuure values of no and r. Equaion (6) can be expressed in his conex as: hz = i= 1 i β i ( g1 γg 2 ) A z [ ], g = [ 0 0 1] and [ 0 1 0] where g = 2 h or as: 1 = CA = kz where k = ( g A 1 1 γ g2) βa( Ι β ) The vecor k has o equal [0 1 0] implying ha CA = CA. This can also be esed empirically. This es, i is imporan o noice, is a join es of he model and of he process of generaion of expecaions in he economy. We will call his es he k-es. 4. The daa The model presened in he previous secion provides us wih a benchmark for undersanding flucuaions in a small open economy s curren accoun. According o ha benchmark, flucuaions in a counry s curren accoun are moivaed by a desire o smooh consumpion in a conex of changing relaive prices and changing expecaions abou fuure income. The following secions will ake his benchmark model o he daa. Bu before ha, his secion describes he daa employed in he empirical analysis and how he relevan variables and parameers are defined. The daa includes all member counries of he EMU excep Luxemburg, whose curren accoun, we believe, is mosly affeced by differen mechanisms han he ones considered in our benchmark model. We are ineresed in undersaing he flucuaions in he curren accoun of hese counries over he las hree decades. We follow he lieraure and use quarerly daa seasonally adjused a annual frequency. 16 The use of quarerly daa excludes Greece from he analysis since we could no find daa of his frequency for his counry ha were comparable o 16 I has been shown in he lieraure ha he empirical evaluaion of ineremporal curren accoun models using annual daa produces misleading resuls. IESE Business School-Universiy of Navarra - 9

13 ha of he oher counries. Unless oherwise noed, all he daa comes from he Inernaional Financial Saisics (IFS) consruced by he Inernaional Moneary Fund. The variables needed for he analysis are defined as follows. Curren accoun ( CA ) is defined as he difference beween ne oupu (no ) and consumpion (c ). Ne oupu is he log of GDP (Y ) minus governmen expendiure (G ) and invesmen expendiure (I ). Consumpion is he log of privae consumpion expendiure (C ). All hese variables are expressed in per capia erms in order o accommodae he daa o he represenaive consumer assumpion of he model. 17 We use he ex-ane world real ineres rae as a measure of he world real ineres rae (r ) in he model. This is compued as he difference beween he one year world nominal ineres rae and expeced inflaion, where expeced inflaion is calculaed from a forecas based on a 6 quarer window. Bergin and Sheffrin (2000) define he world shor-erm nominal ineres rae combining shor-erm nominal ineres raes, T-bill raes or equivalen measures for he G-7 counries. They hen apply his common world ineres rae o all heir counries. Here we follow a differen approach. In paricular, we define he world shor-erm nominal ineres rae for each counry as he Shor-Term Ineres Rae provided by he OECD Economic Oulook. 18 Excep for he period afer he inroducion of he Euro, his world nominal ineres rae differs across counries. We believe, however, ha his provides a beer represenaion of he world ineres raes faced by each counry han he one used in Bergin and Sheffrin (2000). As menioned in secion 3, we follow Rogoff (1992) and Bergin and Sheffrin (2000) and we use he ex-ane real exchange rae as a proxy for P. In paricular, we use he real effecive exchange rae consruced by he IFS using relaive uni labour coss, and we consruc he exane real effecive exchange rae again from a forecas based on a 6 quarer window. 19 Finally, and following he lieraure, we focus on he dynamic implicaions of he model and de-mean all he relevan variables relaive o heir sample mean. We also need o give values o he hree parameers of he model: a, he relaive share of raded goods in consumpion, β, he discoun rae, and γ, he ineremporal elasiciy of subsiuion. The share of raded goods in consumpion is esimaed from he inpu-oupu informaion for every counry provided by Eurosa. This daa refers o 1995 for mos counries. Given ha 1995 lies in he laer par of our sample and ha he consumpion of no raded goods in developed economies is likely o have increased over ime, he raio of raded goods in consumpion is likely o have been higher in he earlier par of he sample. Neverheless, we believe his o be an appropriae approximaion and he resuls o be robus o his parameer. 1 For he discoun rae, we defined i as β =, where r denoes, for each counry, he 1 + r average of he quarerly real ineres rae during he period. There exiss a wide range of esimaes for he ineremporal elasiciy of subsiuion in he lieraure depending on he conex and manner in which i is esimaed. In his sense, while 17 Populaion daa comes from he OECD Economic Oulook. 18 The OECD Economic Oulook does no provide his informaion for Ausria. Thus, for he empirical analysis, we consruced he world shor-erm nominal ineres rae for Ausria combining he informaion abou he Money Marke rae provided by he IFS for his counry prior o he creaion of he Euro wih he shor-erm nominal ineres rae in he Euro area afer he inroducion of he Euro. 19 For Porugal, we use a real effecive exchange rae compued based on relaive consumer prices as he IFS does no provide for his counry he one based on relaive uni labour coss IESE Business School-Universiy of Navarra

14 Hall (1988) esimaes i o be small and unlikely larger han 0.1, ohers have provided esimaes much closer o one (see, for example, Beaudry and van Wincoop (1996)). Given he lack of agreemen in he lieraure abou his parameer, we ake a neural approach and provide resuls for several values of γ on he inerval (0,1). In paricular, we consider 0.1, 0.25, 0.5, 0.75 and We believe hese numbers cover all he reasonable range for he value of his elasiciy. Table 1 shows for each counry some basic informaion abou he parameer values and he daa used in he esimaion considering γ = The firs row repors he sample period used for each counry. This is he longes ime period for which all he needed informaion is available and, for mos counries, i goes from he lae 1970s o There are wo excepions, Germany and Ireland. For Germany daa only sars in 1991 afer he re-unificaion and for Ireland quarerly daa is only available saring in This cerainly affecs he abiliy of he model o explain he curren accoun flucuaions in hese counries. The model described above implicily considers ha no, CA and r are saionary variables. In fac, i would be difficul o jusify ha hese variables were no saionary over a long period of ime. In a shor period of ime, however, some of hese variables could be non-saionary. Then, inuiively, given ha one of he implici assumpions of he model is no saisfied, i should no be surprising o find a poor empirical fi of he model when evaluaed in such a shor period of ime. As i will be clear below, his is wha i will happen, o some exen, for Germany and Ireland. The share of raded goods ranges from 0.26 in Neherlands and Finland o 0.42 in Porugal. There is a negaive correlaion beween his share and per capia income. 21 The richer European counries end o have a lower share han he relaively poorer counries. The discoun facor does no show many differences across counries, alhough i is slighly lower for Belgium, Finland and Ialy. Belgium and Ialy were he wo counries wih he larges raio of deb o GDP during he period maybe indicaing he exisence of a risk premium in heir discoun facor. Large differences exis in he mean values of our measure of he curren accoun among counries. Porugal has by far he smalles mean value a In conras, Ireland shows he larges surplus, 0.27, alhough he sample period for Ireland is subsanially shorer. In undersanding hese numbers, i is imporan o recall ha our measure of he curren accoun is approximaely equal o a counry s exernal balance over consumpion. Neherlands also shows a large mean surplus of 7.66% over a 29 year period. All he oher counries have posiive mean curren accoun balances excep Spain, alhough heir absolue values are subsanially smaller. 5. Tesing he ICA model Table 2 presens he resuls of he R-es, he k-es and he Granger causaliy ess. These ess use he longes ime period available for each counry and hey are performed for each of he five values of γ described in he previous secion. 20 Bergin and Sheffrin (2000) also consider differen values of γ in heir empirical analysis. In addiion, hey presen he resuls of heir model for an esimaed γ, defined as he value of γ ha maximizes he p-value of he k-es of he model. We found his esimaed γ o be exremely non-robus o minor changes in he specificaion of he model and ha is why we did no pursue ha approach here. 21 This correlaion is abou IESE Business School-Universiy of Navarra - 11

15 Recall ha he R-es consiss on esing if E( 1 ) = 0. To implemen his es we simple R Ι regress R on lags of no, CA and r, ha is on I, and es he null hypohesis ha he esimaed coefficiens associaed o he independen variables are all zero. The k-es of he model, as described in secion 3.1, ess he null hypohesis ha he vecor k is equal o [0 1 0]. 22 Bergin and Sheffrin (2000) show ha his es can be implemened using he dela mehod o consruc a χ 2 saisic for ha hypohesis. The values repored on Table 2 for hese wo ess correspond o he p-values associaed o he null hypohesis. Finally, recall ha variable X Granger causes variable Y if i provides any saisically significan informaion abou Y in he presence of lagged Y. Thus, a naural way of implemening his es is o regress Y on lags of Y and X, and hen es he null hypohesis ha he esimaed coefficiens associaed o he lags of X are all zero. Table 2 repors wo values for he Granger causaliy ess. The firs value corresponds o he p-value associaed o esing he hypohesis ha CA does no Granger cause [ no γr ]. The second value of he Granger causaliy es provided in he able is he p-value associaed o esing he hypohesis ha [ no γr ] does no Granger cause CA. In his case, a rejecion of he model a a 10% significance level requires ha he firs p-value be greaer han 0.1 and he second p-value be smaller han 0.1. Table 2 also provides informaion abou he number of lags considered for each counry and each value of γ, which is relevan for he consrucion of all he hree ess menioned above. This number of lags is deermined applying he Akaike s, he Schwarz s Bayesian, and he Hannan and Quinn Informaion Crieria o he vecor auo regression composed of variables no, CA and r. When hese hree crieria indicae differen number of lags, we use he mode of he recommendaion. For he case in which all hree sugges alernaive number of lags, he Akaike s Informaion Crieria (AIC) always suggess he larges number. Then, given ha he AIC is known o be biased oward selecing more lags han needed, in hose cases we choose he middle esimae of he hree crieria. The evidence from he R-es indicaes ha he ineremporal model is rejeced for all differen values of γ for Ausria, Finland, Germany and Ireland. For he oher six counries (Belgium, France, Ialy, Neherlands, Porugal and Spain), he model is always rejeced for values of γ equal or above 0.75, bu is never rejeced for values of he ineremporal elasiciy of subsiuion below The k-es corroboraes mos of he conclusions of he R-es. Namely, (i) he model is always rejeced for Ausria, Finland, Germany and Ireland, and (ii) he model can no be rejeced for Belgium, France, Ialy and Neherlands as long asγ < There are, however, some discrepancies beween he wo ess. In paricular, according o he k-es: (i) he model is always rejeced for Porugal, (ii) he model can no be rejeced for Spain only when γ = 0. 5, and (iii) in some insances he model can no be rejeced eiher for Belgium, France, Ialy and Neherlands whenγ Mercereau and Miniane (2004), show ha he k-es may produce 1 22 The vecor k is a hree-dimensional vecor only for a VAR(1). For counries for which a VAR(2) is used k is a vecor wih six elemens. The null hypohesis in ha case is ha k is equal o [ ]. 23 We place he level of rejecion a he 10% significance level IESE Business School-Universiy of Navarra

16 misleading resuls if one of he series in he VAR is highly persisen. 24 This is ypically he case for he curren accoun in he counries in our sample. Therefore, we place more emphasis on he predicions of he R-es in inerpreing hese small discrepancies beween he wo ess. Finally, he Granger causaliy ess produce mixed resuls ha are difficul o conciliae wih he resuls of he previous wo ess. This is also he case in mos of he empirical applicaions of ineremporal curren accoun models in he lieraure. This is no surprising since hese ess are really weak ess of he model. For his reason, we follow he lieraure and do no place oo much emphasis on he resuls of hese ess. In order o assess he robusness of he resuls presened in Table 2 we evaluae heir sensiiviy o differen ime periods. Table 3 presens he same informaion as Table 2 for five differen ime periods (1980q1-2005, 1985q1-2005, 1990q1-2005, 1980q1-1998q4 and 1977q1-1998q4). 25 The resuls are broadly consisen wih he ones presened in Table 2. Namely, (i) he model is always rejeced for Ausria and Finland, and (ii) in mos of he cases i is no possible o rejec he model for Belgium, France, Ialy, Neherlands, Porugal and Spain for small values of γ. Summing up, we view his empirical exercise as providing broadly suppor o wo main conclusions. Firs, ha he model is rejeced for Ausria, Finland, Germany and Ireland regardless of he value of γ. As menioned above, rejecion for Germany and Ireland is no surprising given heir small sample periods. Finland is also a somewha special case given is special economic relaionship wih he former Sovie Union, especially in he early par of he sample. Rejecion for Ausria is harder o explain. And second, ha for he oher six counries (Belgium, France, Ialy, Neherlands, Porugal and Spain) rejecing he model is more difficul especially for values of he ineremporal elasiciy of subsiuion smaller han Implicaions from he ICA model: curren accoun dynamics The resuls presened in he previous secion indicae ha i is no possible o rejec our benchmark model for Belgium, France, Ialy, Neherlands, Porugal and Spain as long as he ineremporal elasiciy of subsiuion is no oo big. Flucuaions of he curren accoun balances in hese counries over he las hree decades can be undersood as he reacion of hese counries o changing expecaions abou fuure income and relaive prices in heir aemp o smooh heir consumpion over ime. Given he performance of he model for hese six counries and for small values of γ, we explore in his secion more of is implicaions. In doing ha, we focus, in he case in which γ = We choose o show he addiional implicaions of he model for his value of γ for exposiional convenience and because i is broadly in he middle of he range of values of γ for which he model performs well. Mos of he resuls presened below also hold when γ = 0. 1 or γ = 0.5. Table 4 repors, for each counry, he esimaes of he parameers composing he VAR companion marix in equaion (7) wih heir corresponding sandard errors. As he heory suggess, ceeris paribus, a curren accoun surplus predics smaller changes in ne oupu in he 24 Wih high persisence in one of he VAR series, he dela mehod approximaion needed o es he null hypohesis of he k-es is less accurae. 25 Germany and Ireland are no included in his exercise given heir small sample sizes. IESE Business School-Universiy of Navarra - 13

17 fuure. The esimae of no : LCA is negaive for all counries wih he excepion of France. 26 Consisen wih he heory, we also find ha, ceeris paribus, a curren accoun surplus implies higher consumpion-based real ineres raes in he fuure. The esimae of r : LCA is posiive for all counries. Mos of hese coefficiens, alhough wih he expeced sign, are saisically insignifican, as expeced given he mixed performance from he Granger causaliy analysis discussed above. Table 5 repors, for each counry, he esimaes of he parameers composing he k vecor, wih heir corresponding sandard errors. As shown in Table 2, i is no possible o rejec ha he k vecors for Belgium, France, Ialy and Neherlands are equal o he predicions of he model. I is rue, however, ha he esimaed parameers have very large sandard errors and ha, in some cases, he poin esimaes are far from heir expeced values. For insance, he poin esimae of he coefficien on CA for Neherlands, alhough no saisically differen from 1, is below 0.5. In conras, Porugal has a poin esimae of he k vecor far from he model s predicion and rejecs he null hypohesis of he k-es. Spain, se on he margin of rejecing he null hypohesis of he k-es according o Table 2, has poin esimaes of he componens of he k vecor closer o he model s predicion. Figure 3 shows, for each counry, he evoluion over he sample period of he prediced curren accoun, compued according o he esimaed k vecor, and of he acual curren accoun. From he figure, i is clear ha he model makes a relaively good job in capuring, qualiaively, he flucuaions in each counry s curren accoun. Quaniaively, however, he model performs beer for France and Ialy (he fi is almos perfec) han for he oher counries. The op panel in Table 6 complemens he impressions obained from he visual analysis in Figure 3. The firs row of Table 6 repors, for each counry, he raio of he sandard deviaion of he acual and he prediced curren accouns. This raio is almos equal o 1 for France and Ialy, i is clearly above 1 for Belgium and i is subsanially below 1 for Neherlands, Porugal and Spain. The fac ha he prediced curren accoun for he las hree counries exhibis less volailiy han he acual one should no be surprising since his is a common feaure of he empirical applicaions of ineremporal curren accoun models in he lieraure (see Obsfeld and Rogoff, 1995). 27 Insead, i is somehow surprising, given his evidence, he excess volailiy we find in he prediced curren accoun for Belgium. An alernaive summary saisic of he relaive performance of he model is he average over he sample period of he raio of he prediced value of he curren accoun and is acual value. This raio is repored in he fourh row of Table 6. This raio is almos one for France and Ialy, larger han one for Belgium, and smaller han one for Neherlands, Porugal and Spain. For hese laer counries, he model no only under-predics he volailiy of he curren accoun buy also is level. Curren accoun flucuaions in he model are due o changes in expecaions abou fuure ne oupu or abou fuure relaive prices. We can use equaion (6) o decompose he prediced 26 For France, we do find, however, ha he coefficien of he effec ha second lag of he curren accoun has on oupu is also negaive. 27 There have been a number of suggesions in he lieraure o increase he volailiy of he curren accoun prediced by ICA models. For insance, Gruber (2004), shows ha including habis in he consumers uiliy funcion helps a lo in maching he observed volailiy IESE Business School-Universiy of Navarra

18 curren accoun ino hese wo componens. In paricular, we can express he prediced curren accoun as: CA = E i= 1 i i β ( no ) E β ( γ r ) (8) + i + i= 1 + i where x denoes he esimaed value from he VAR of variable x. The second and hird rows in Table 6 repor he average percenage conribuion o he prediced curren accoun of hese wo componens over he sample period. 28 Figure 4 also shows, for each counry, he relaive conribuion o he prediced curren accoun of hese wo erms hroughou he sample period. There are imporan differences across counries. Expecaions of fuure relaive prices are he key componen of he curren accoun flucuaions prediced by he model for France, Ialy and Neherlands. For he las wo counries hey represen above 70% of hese flucuaions. Insead, for Belgium, Porugal and Spain, he key componen are he expecaions of fuure oupu changes, especially for Porugal where hey represen more han 80% of he prediced flucuaions. The resuls above show ha curren accouns over he las few decades in Belgium, France, Ialy, Neherlands, Porugal and Spain are broadly consisen wih heir ciizens smoohing consumpion according o heir expecaions abou fuure income and abou fuure relaive prices. Thus, according o our benchmark model, he size and susainabiliy of curren accoun imbalances in hese counries depend on he feasibiliy of he expecaions abou fuure oupu and relaive prices which are driving hem. The emphasis on feasibiliy is key. If hese expecaions urn ou o be far from wha seems like a reasonably feasible oucome presen curren accouns may signal fuure poenial problems. This is, for insance, he concern posed by Gourinchas (2002) when analyzing he evoluion of curren accoun deficis in some Euro area counries. If hese counries expecaions are over-opimisic or, simply, unrealisic, large curren accoun deficis based on consumpion smoohing may lead o sharp adjusmens on he curren accoun once hese expecaions are no realized. 29 We can use he decomposiion of he deerminans of he curren accoun highlighed above o exrac more informaion abou he counries expecaions abou fuure ne oupu and relaive prices. We will focus on he expecaions abou fuure ne oupu. To begin wih, noe ha one can manipulae equaion (8) and rewrie he curren accoun prediced by our benchmark model as: CA = ( ) no no + E i= γ β r (9) 1 i + i where no is defined in such a way ha: E 1 + no (10) β i i β no i = β no = i= 0 i= In order o focus on he sources of variaion for balances away from zero, we have only compued he breakdown for he subse of observaions for which CA > The lieraure has named hese sharp adjusmens curren accoun reversals. IESE Business School-Universiy of Navarra - 15

19 In words, equaion (10) simply saes ha no is he level of ne oupu such ha an infinie flow of ne oupu fixed a ha level has he same presened discouned value as he flow of ne oupu expeced by he counry s represenaive consumer, { + i } i=0,1,2,... no. Thus, in a sense, no has a similar inerpreaion o he permanen income in consumpion models and we will refer o i as he counry s srucural ne oupu. Wih his concep in mind, he consumpion smoohing inerpreaion of equaion (9) is very clear: absracing from he role of he consumpion-based real ineres rae, a counry mus experience a curren accoun defici when his srucural ne oupu is greaer han his curren ne oupu and, herefore, i is expecing o grow. The idea of he srucural ne oupu allows evaluaing, o some exen, he feasibiliy of a counry s expecaions abou is fuure ne oupu which, according o our benchmark model, are he driving force behind is curren accoun balances. To begin wih, Figure 5 shows he evoluion over ime of he raio of each counry s srucural ne oupu ( no ) o is curren ne oupu ( no ). There are some ineresing paerns in hese figures. The creaion of he Euro increased fuure oupu expecaions in he Souhern European counries. For France, Ialy, Porugal and Spain he raio of he srucural ne oupu o he curren ne oupu began o increase a some momen in he second half of he previous decade and coninued increasing unil approximaely Since hen he paern has differed across hese counries. While all counries experienced a downward adjusmen in his raio around ha period, for France and Spain i quickly sared again an upward rend ha coninues oday. For Ialy, however, he raio sabilized and for Porugal i has coninued o decrease reflecing more conservaive Poruguese expecaions abou is fuure growh. The experiences of Belgium and Neherlands are compleely differen. For hese counries, he raio of he srucural ne oupu o he curren ne oupu, alhough flucuaing, has exhibied no rend around or since he creaion of he Euro. An alernaive way of evaluaing he feasibiliy of each counry s expecaions abou is fuure ne oupu is o compue, for each counry, some implied growh raes from his fuure ne oupu and o compare hem wih hisorical growh raes. This can be approximaed by he following exercise. Focusing on he las observaion for each of our six counries (=T), ne oupu equals no T and each counry s represenaive consumer expecaions abou fuure ne oupu are given by{ no T + i }, wih an associaed srucural ne oupu equal o no. i=0,1,2,... T By definiion of he srucural ne oupu we know ha: E i β not + i = i= 0 i= 0 i β no T Now noe ha he fuure ne oupu flow expeced by he counry s represenaive consumer, { no T + i } i=0,1,2,..., may be very erraic. Insead, le us consider a smooher one wih he same presen discouned value. In paricular, consider ha he counry s ne oupu grows, saring a no T, a consan rae g(p) during P periods (quarers) and hen says a he reached level, no P, forever. This smooher flow has he same presen discouned value as { no T + i } as i=0,1,2,... long as g(p) saisfies he following equaion: 30 For Porugal his raio declined briefly around 1999, bu his decline was quickly revered IESE Business School-Universiy of Navarra

20 E i= 0 P i i i β not + i = β ( not + ig( P)) + β nop (12) i= 0 i= T + 1 where no = no Pg(P) P T + Obviously, g(p) is a decreasing funcion of P. The longer a counry has o reach is consan level of oupu, he smaller he growh rae in he inerim period will have o be. Table 7 repors he resuling g(p) for several values of P. In paricular for P equal o 12, 20, 40 and 80 quarers, which correspond o ransiion periods of 3, 5, 10 and 20 years, respecively. The firs panel of Table 7 repors he values of g(p) compued according o equaion (12) and expressed in annual erms. When analyzing hese numbers i is imporan o noe ha, in our analysis, all he relevan variables have been demeaned, and ne oupu (no) is a zero-mean variable. The g(p) numbers should be inerpreed as incremenal growh raes beyond each counry s growh rae over he sample. For ha reason, he second panel of Table 7 repors he same annual growh raes of he firs panel bu expressed relaive o each counry s sample means. Counries whose curren ne oupus ( no T ) are above heir srucural ne oupus ( no T ) have expecaions of fuure growh ha are below heir hisorical levels. This is he case for of Belgium, Neherlands and Porugal. On he opposie side, France, Ialy and Spain, have curren ne oupus in he las period ( no T ) below heir srucural ne oupus ( no T ). Thus, hey have expecaions of fuure growh ha are above heir hisorical levels. Belgium and Spain are he wo mos salien counries. They are, by far, he counries wih he mos pessimisic and opimisic expecaions, respecively, abou fuure ne oupu growh. According o our esimaes, on a 5 years ime period, Belgium s expecaions would imply a growh 24% slower han is hisorical mean. Spanish expecaions, insead, are a an hisorical high (as illusraed in Figure 5) and would imply a growh over he same period of ime 44% faser han is hisorical mean. If we assume ha he shares of governmen expendiure and invesmen o GDP remain consan, his is equivalen o an increase in GDP per capia during his period of similar magniude. 31 Moreover, i is somehow worrisome ha, despie considering hese high expecaions of oupu growh in Spain, he model can only explain 64% of he Spanish acual curren accoun defici a he end of 2005 (hird row in he las panel of Table 6). 7. Robusness checks and furher discussion The empirical analysis developed above imposed, for each counry and for he whole period of analysis, sabiliy of he VAR parameers ha deermine he way in which consumers form expecaions abou fuure ne oupu and relaive prices. One could argue agains his assumpion of sabiliy ha he creaion of he EMU and he inroducion of he Euro have modified he way consumers use pas informaion o form hese expecaions. In his sense, he drasic implicaions ha he Euro has had on member counries in erms of real ineres raes and volailiy of exchange raes, srongly sugges he possibiliy of a srucural break in he formaion of expecaions oo. Srucural break in his conex implies ha he VAR parameers 31 In Spain, however, he share of invesmen o GDP in 2005 was subsanially higher han he hisorical average. Thus, par of his adjusmen could ake place by a reversal of he share of invesmen in GDP o is hisorical average. IESE Business School-Universiy of Navarra - 17