Working Paper: NBER ID: w12620
Authors: Sebastian Edwards
Abstract: During the last three years New Zealand has faced increasingly large external imbalances. The current account deficit has increased from 4.3% of GDP in 2003 to almost 9.0% of GDP in 2005. During the same period the country's net international investment position (NIIP) went from a negative level equivalent to 78.5% of GDP to negative 89% of GDP. In this paper I analyze the potential consequences of New Zealand's external imbalances. More specifically, I investigate what is the probability that New Zealand will undergo a costly adjustment characterized by an abrupt and large current account reversal. I find that to an important extent the (very) negative NIIP and (very) large current account deficit may be explained by New Zealand's very close economic relationship with Australia. The econometric results suggest that the rapid growth in the deficit during the last few years has (greatly) increased New Zealand's vulnerability to "contagion." It has also increased the advantage of the country's current floating exchange rate regime.
Keywords: New Zealand; current account; external imbalances; monetary policy; economic vulnerability
JEL Codes: F1; F14; F31; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| New Zealand's very negative NIIP and large current account deficit (F32) | external imbalances (F32) |
| current account deficit (F32) | adjustment process for New Zealand's current account deficit will be costly in terms of lower GDP growth (F32) |
| monetary policy (E52) | external imbalances (F32) |
| countries with large current account deficits (F32) | higher risk of experiencing sudden stops in capital inflows (F65) |
| current account deficit (F32) | probability of experiencing a sudden stop in capital inflows (F32) |
| rapid growth in current account deficit (F32) | probability of experiencing abrupt current account reversal (F32) |