Working Paper: CEPR ID: DP14104
Authors: Evi Pappa; Markus Brueckner; Wojtek Paczos
Abstract: We examine the relationship between domestic saving and the current account in developing countries. Our three main findings are that domestic saving has: (i) a small effect on the current account; (ii) a significant positive and quantitatively sizable effect on the trade balance; (iii) a significant negative effect on net-current transfers. We use countries in the sub-Saharan African region as a laboratory for an instrumental variables approach. The IV approach enables to obtain estimates of causal effects. Underlying the IV approach is the significant positive first-stage response of domestic saving to plausibly exogenous annual rainfall: an unanticipated, transitory supply-side shock. We construct a small open-economy DSGE model with debt adjustment frictions and endogenous net-current transfers to match the empirical findings. The model enables to examine how other types of shocks – such as changes in interest rates or trend TFP for which it is hard to get exogenous variation in the data – affect the relationship between domestic saving and the current account. An important implication of our findings is that, for developing countries, estimates of the relationship between domestic saving and domestic investment are not informative for answering the question how domestic saving affects a country's accumulation of net foreign assets.
Keywords: domestic saving; current account; net current transfers; small open economy model; financial frictions; Feldstein-Horioka puzzle
JEL Codes: F32; F35
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Domestic Saving (D14) | Current Account (F32) |
| Domestic Saving (D14) | Trade Balance (F14) |
| Domestic Saving (D14) | Net Current Transfers (F16) |