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Current account deficit sustainability: The case
GreeceNicholas Apergis
a, Konstantinos P. Katrakilidis
b& Nicholas M. Tabakis
c
aUniversity of Macedonia, Greece
bAristotle University of Thessaloniki, Greece
cTechnological Educational Institute of Thessaloniki, Greece
Available online: 06 Oct 2010
To cite this article: Nicholas Apergis, Konstantinos P.
Katrakilidis & Nicholas M. Tabakis (2000): Current account
deficit sustainability: The case of Greece, Applied Economics
Letters, 7:9, 599-603
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Current account decit sustainability: The
case of Greece
N I C HOL A S A P E R G IS , K ON S T A N TI N OS P. K A T R A K
I L I DI S{*and N I C H OL A S M . T A B A K I S }
University of Macedonia, Greece, {Aristotle University of T
hessaloniki, Greece and} Technological Educational Institute of
Thessaloniki, Greece
Received 7 December 1998
The objective of this paper is to investigate the sustainability
of the current accountdecit in Greece over the 19601994 period. The
empirical analysis makes use of
various unit root and cointegration tests which allow for
structural breaks. Theresults provide evidence in favour of the
sustainability of the current account decitand against a required
(and unnecessary) devaluation of the drachma.
I . I N T R O D UC T I O N
The `twin decits problem has been one of the mostdebated issues
in relevant literature over the last fewyears. In particular, the
hottest related issue concerns thesustainability of persistent
account decits, a concern thathas been motivated by the severe debt
servicing problems
that many developing countries have to cope with as wellas by
the large and persistent current account imbalancesfaced by the
three largest industrial countries, i.e. the USA,Japan and
Germany.
The persistent presence of any payments imbalanceraises a major
concern because of the undesirable conse-quences of a ` forced
adjustment required by both the pri-vate and the public sector. In
this case the economy is noton a long-run steady-state path and
certain variables andpolicies must change (Zee, 1988). In general,
it is extremelycrucial the information for the persistence or not
of anyexternal imbalance to be known because, at some point,
theability of a country to service and repay its debt will
bequestioned and that it will not default on its debt (Wickensand
Uctum, 1993). Crockett and Goldstein (1987) denesustainability as:
(1) a countrys capacity to service debt outof current and expected
foreign exchange earnings; (2) thecountrys consistency of
savings-investment preferenceswith respect to other countries; and
(3) the countrys rea-sonable targets of full employment.
According to Hakkio (1995) short-run or temporary crent account
decits are not expected to create any seriproblems as they reect
reallocation of capital to the cotry that this factor of production
tends to receive the hest possible return. In contrast, long-run or
persiscurrent account decits tend to have certain harmful eon the
domestic economy. In particular, they tend
increase domestic interest rates relative to their
forecounterparts, while simultaneously, they impose an exsive
burden on future generations, and thus lower standof livings, which
will have to pay back high amountaccumulated external debts. Most
of the empirical reseahas been conducted with respect to the US
econo(Hakkio and Rush, 1991; Haug, 1991, 1995; Hus1992; Tanner and
Liu, 1994; Liu and Tanner, 1995).
The objective of this study is to test for the sustainabof the
Greek current account decit and to assess whethdevaluation to
correct the imbalance position is requiredis known that over the
last 2025 years the Greek econohas experienced persistent current
account decits, partlarly after 1980, while the severity of those
decits has baggravated by the implementation of the ` hard
drachpolicy since 1991 as an anti-inationary tool. At same time,
the countrys public debt has reached exceptally high gures leading
to exceptionally high interest raFinally, since 1994 the exchange
rate policy has been dited to follow closely DM trends. However, by
defend
Applied Economics L etters ISSN 13504851 print/ISSN 14664291
online # 2000 Taylor & Francis Ltd
http://www.tandf.co.uk/journals
Applied Economics L etters, 2000, 7, 599603
*Corresponding author.
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the drachma/DM exchange rate, the monetary authoritiesare
required to provide enough liquidity (foreign reserves)into the
process. Without sucient liquidity (`liquiditycrunch) such a pegged
rate leads to a currency crisis. Inaddition, the progressive
integration of the internationalnancial market allows the monetary
authorities to borrowabroad to defend its currency, i.e. to defend
the sustain-ability of the pegged regime. However, if foreign
lenders
believe that the borrower will not be capable of reimbur-sing
their loans, borrowing abroad will be denied (Milesi-Ferretti et
al., 1996a, 1996b). Thus, it seems reasonable toinvestigate the
sustainability of the intertemporal currentaccount.
The empirical analysis makes use of various forms of
thecointegration technique, and in particular, those forms
thatallow the presence of any structural break(s) in the
cointe-grating vector. The results indicate that the hypothesis
ofcurrent account decit sustainability is conrmed for theGreek
case. The rest of the paper proceeds as follows.Section 2 presents
the theoretical background, while
Section 3 provides the empirical results. Finally, Section4
concludes the paper and provides some policy lessons.
I I . T H E O R E T I C A L B A C K G R O U N D
In the intertemporal balance model, the reserves are
accu-mulated periodically from a current account. It is only asolid
current account that generates enough reserves tovindicate a
sustainable current account decit.
Husted (1992) uses the behaviour of the stock of inter-national
debt to determine whether the budget constraint isexpected to be
intertemporally balanced. The equation ofthe budget constraint in
the current period t is given by
Ct Yt Bt It 1 rtBt1 1
where Ct, Yt, Bt, It, and rt are consumption, output,
inter-national borrowing, investment, and the one period ofworld
interest rate, respectively. 1 rtBt1 representsthe initial debt,
corresponding to the countrys externaldebt.
From (1) we get:
Bt Bt1 rtBt1 T Bt 2
where T Bt Xt IMPt Yt Ct It represents the
trade balance (exports, Ximports, IMP).In order to derive a
testable model following Husted
(1992) and Wu et al. (1996) and to test for the hypothesisof
current account sustainability, Equation 2 is trans-formed into an
equation of the following form:
Xt a bIMP vt 3
where Xt is exports of goods and services, while IMPtmeasures
imports of goods and services plus net transferpayments and net
interest payments. If b equals one, thencurrent account
sustainability holds and vt should be sta-
tionary. By contrast, if b < 1 then the hypothesis of
tainability is violated. In this case, the economy is expecto
default on its international debts (Hakkio and Ru1991; Husted,
1992).
I I I . E M P I R I C A L R E S U L T S
Data
The empirical analysis is carried out using annual data othe
period 1960 to 1994 on exports of goods and serv(X), imports of
goods and services (M), net transfer pments (NTP) and net interest
payments (NIP). FollowWu et al. (1996) the measure of imports
involIMP= M+ NTP+ NIP while both exports and impare measured in
real terms and scaled by real GDP.variables are expressed in
drachmas. Data were obtaifrom the Monthly Statistical Bulletin of
the BankGreece.
Integration and cointegration analysis without breaks
Table 1 reports the results of Dickey-Fuller (1981) unit rtests
on the rst dierences as well as on the levels ofvariables. The
results are consistent with real exports real imports being I(1),
e.g. integrated of order one. Havestablished that the two series
under examination are processes, a Vector A utoregressive (VAR )
model is polated. The likelihood ratio (LR) test, proposed by
S(1980), was used to evaluate the choice of the lag struct
Next, multivariate cointegration tests developed Johansen and
Juselius (1990) and based on a 2-lag Vmodel, were applied. The
results of the cointegration tare reported in Table 2. They
recommended the absencany cointegrating vector between exports and
impoTherefore, we cannot decide whether the current accodecit is
sustainable or not. However, the absence of cointegrating
relationship could be due to the fact thatanalysis did not allow
for the presence of possible breThe Zivot-Andrews (1992) test was
then employed
600 N. Apergis et
Table 1. Unit root tests
Variable ADF(F) ADF(T)
XLevels 71.46(3) 71.00(2)First-dierences 74.90*(1) 76.00*(1)
IMPLevels 71.06(2) 70.61(2)First dierences 74.29**(1)
74.97*(1)
Notes: ADF(F) is the t-ratio without trend and ADF(T) is the
t-ratio
trend. Numbers in parentheses denote the number of lags in the
mented term. * signicant at 1%, ** signicant at 5%.
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detect the presence of any possible break in the variablesunder
investigation.
Integration analysis with endogenous breaks
In order to capture any possible structural shift over
theestimation period, the Zivot and Andrews (1992) method-ology is
used which treats the presence of any structuralbreak in the series
under investigation endogenously. Theproposed test uses the
following equations:
Yt m aDUt bTIME cYt1 Xq
i 1
diDYt1 vt
4
where DUt 1 if t > T, 0 otherwise, and Yt is exportsand
imports; and
Yt m aDTt bTIME cYt1 Xq
i 1
diDYti vt
5
where DTt t T if t > , 0 otherwise, and isdened as the
fraction TB=T, with TB being the breakpoint. The rst equation
detects the presence of any poss-ible mean break, while the second
equation detects thepresence of any possible slope break. The
strategy involves
the estimation of the above regressions through OLS frt 2 to t T
1. For each value of the t-statistictesting c 1 was obtained. The
break year correspondthe minimum t-statistic over all T 2
regressions.
More specically, in our case, the above equations westimated
over the period 1962 to 1993. Each time appropriate dummy variable
(DU or DT) was employThe results, presented in Table 3, report the
minimum
statistics and their corresponding time breaks. Accordto those
values, the mean break point seems to coincid1974, the year in
which drachma was allowed to uctuindependently of the US dollar,
while the slope break pcoincides to 1980, when Greece became a full
membethe European Economic Community (EEC).
Cointegration analysis with breaks
Once the Zivot-Andrews test identied the presence omean break
point at 1974 as well as a slope break poin1980, Gregory and
Hansens (1996) cointegration meth
ology was applied. This methodology examines the pence of
cointegration under possible regime-shifts.particular, Gregory and
Hansen (1996) are concerwith the possibility of a general type of
cointegratwhere the cointegrating vector is allowed to change
asingle unknown time during the sample period; a structchange would
be reected in changes in the intercept m aor changes to the slope
and is usually modelled as bel
Model 1: level shift (C)
y1t 1 2t Ty2tet ; t 1; . . . ;n
where m1 represents the intercept before the shift, and
represents the change in the intercept at the time of shift. y1t
and y2t, in the context of our analysis, arand IMP respectively.
The dummy variable t, is deby:
t 0; if t 1; if t >
where the unknown parameter 2 0;1 denotes the (rtive) timing of
the change point, and [ ] denotes intpart.
Model 2: level shift with trend (C/T)
y1t 1 2t -t Ty2t et ; t 1; . . . ; n
where t represents a time trend.
Model 3: Regime shift (C/S)
y1t 1 2t T1 y2t
T2 y2tt et ; t 1; . .
where 1 denotes the cointegrating slope coecients bethe regime
shift, and 2 denotes the change in the slcoecients.
Current account decit
Table 2. Johansen-Juselius cointegration tests
Cointegration LR Test Based on Maximal Eigenvalue of the
StochasticMatrix
Null Alternative Statistics 95% Crit. Value 90% Crit. Valuer 0 r
1 10.234 15.672 13.752r 1 r 2 2.070 9.243 7.525
Cointegration LR Test Based on Trace of the Stochastic
Matrix
Null Alternative Statistics 95% crit. Value 90% crit. Valuer 0 r
1 12.304 19.964 17.852r 1 r 2 2.070 9.243 7.525
Notes: List of variables included in the cointegrated vector: X
IMP inter-
cept; and 35 observations from 1960 to 1994. Maximum lag in VAR=
2.
Table 3. Zivot-Andrews break tests
Variable Mean t-test Year
X 70.56 [3] 1974IMP 73.22 [2] 1974
Variable Slope t-test Year
X 73.05 [1] 1980IMP 73.02 [2] 1980
Notes: Numbers in brackets denote the number of lags in the
modied unitroot tests and they were selected through the Akaike
criterion.
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In the context of the above models C, C/T, and C/S
Gregory and Hansen analysed some tests designed todetect
cointegration in the possible presence of breaks.More specically,
for each , they estimated one of theabove models (depending upon
the alternative hypothesisunder consideration ) by OLS, yielding
the residuals et.From these residuals, the Phillips (1987) test
statisticsZa, Zt or the augmented Dickey-Fuller (ADF) sta-
tistic are formed. Note that the above statistics can be
usedalternatively. Next, the smallest values of these
statistics,across all values of 2 T, are used to test the null
hypoth-esis of no cointegration in the possible presence of
breaks.
With regard to our analysis, the results, presented inTable 4,
are referred to the Phillips Zt test statisticand they provide
empirical support for the presence ofcointegration. In particular,
the rst model (the mean
model) reports that cointegration is present with a breakpoint
at 1974, while the second model (the slope model)shows that
cointegration is present with a break point at1980. Finally, the
third model, which takes into considera-
tion the simultaneous presence of both a mean break and aslope
break, exhibits empirical support for cointegrationwith a mean
break point and a slope break point at 1974and 1980,
respectively.
Estimation of cointegrating vectors with breaks
In the nal step of the empirical analysis the
methodologydeveloped by Stock and Watson (1993) is used,
whichallows the (dynamic) estimation of cointegrating vectorsfor
systems involving deterministic components. The esti-
mators can be computed using OLS. The resulting dynamicOLS
(DOLS) estimators perform better comparatively toother
asymptotically ecient estimators. The estimationresults are
reported in Table 5. Furthermore, testing therestriction of the
null hypothesis that the coecienta1 1, we get:
21 1:98[p-value= 0.37], which impliesthat the current account
decit in Greece is sustainable.
The empirical ndings do not recommend a devaluationof the
drachma to correct decits in the current account.Therefore, the
monetary authorities should continue withthe `hard drachma policy
to ght ination and to satisfy
one of the most crucial criteria set by the MaastrTreaty, that
is the low ination criterion.*
I V . C ON C L U D I N G R E M A R K S A N D P OL I CL E S S
ONS
The objective of this paper was to investigate empiricthe
current account decit sustainability hypothesis Greece. In the rst
part of the empirical analysis, convtional cointegration
techniques, that did not allow for presence of any structural
break, did not support hypothesis under investigation. However,
advances in ctegration techniques that consider the presence of
possregime changes, provided evidence in favour of the curaccount
decit sustainability hypothesis. In other woGreece satises its
intertemporal external constraint thus, a devaluation of the
currency seems to be a vremote policy option. However, the
sustainability of crent account is neither a necessary nor a
sucient cdition for the non-change of the drachma. It is nosucient
condition if the devaluation is driven by fullling speculative
currency attacks on an econowith sustainable current account, e.g.
Britain, duringERM crisis over 199293. By contrast, the violation
ofcurrent account sustainability does not necessarily cathe change
of the drachma; if the monetary authorintend to peg their exchange
rate for political reasothey can always change other policies to
bring the curraccount back to balance. These policies can
inclincreasing private or public saving and decreasing invment,
since the current account consists of these paAfter all, a possible
devaluation in a country whicvery vulnerable to international
capital ows and is chacterized by high public debt ratios, is
expected to leadmassive runs against the countrys nancial assets
and eign reserves and, therefore, to a deep recession (Calvo
Mendoza, 1996).
NOTE
At the time of writing this paper (March 1998), the Grmonetary
authorities devalued the drachma by 14%.
602 N. Apergis et
Table 4. Gregory-Hansen cointegration tests
Model Statistic Zt
C 75.226***C/T 74.724*C/S 75.180**
Notes: Critical values were obtained f rom Gregory and Hansen
(1996, p.
109). zt inf2T Zt*** signicant at 1%
** signicant at 5%* signicant at 10%
Table 5. Dynam ic O L S model : Xt a0 a1IMPt a2a3St ut
Coecient a0 a1 a2 a3
70.085 0.9686 0.0958 70.53(6.579) * (10.071) * (6.652)*
(5.27
Notes: The numbers in parentheses are t-statistics for the null
thacorresponding coecients are zero. Dt 0 up to 1974 and 1
therea
and St 0 up to 1980 and S1t IMPt thereafter, with S1t 0 up to
and 1 thereafter. * signicant at 1%
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reason of the devaluation put forward was not the lack ofthe
current account sustainability but the obligation of thedrachma to
fully participate in the exchange rate mechan-ism as well as to
decrease the high level of both the short-and long-term interest
rates (a restriction set by theMaastricht Treaty).
A C KNOW L E DGE M E NT SPaper presented at the 45th A tlantic
Economic Conference,Rome, Italy, 1521 March 1998. The authors would
like toexpress their gratitude to Ho-don Yan. Any errors remain-ing
are their sole responsibility.
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