NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

On the Solvency of Nations: Cross-Country Evidence on the Dynamics of External Adjustment

C. Bora Durdu, Enrique G. Mendoza, Marco E. Terrones

NBER Working Paper No. 18380
Issued in September 2012
NBER Program(s):   IFM

We test the hypothesis that net foreign asset positions are consistent with external solvency and examine the dynamics of external adjustment using data for 50 countries over the 1970-2006 period. Our analysis adapts Bohn’s (2007) error-correction reaction function approach—which tests for a negative long-run relationship between net exports (NX) and net foreign assets (NFA) as a sufficiency condition for the intertemporal budget constraint to hold—to a dynamic panel framework. Pooled Mean Group and Mean Group error-correction estimation yield evidence of a statistically significant, negative response of NX to NFA. Moreover, we cannot reject the hypothesis that the response is largely homogeneous across countries. Our sensitivity analysis shows that the countries with relatively weaker fundamentals need to respond more strongly to the changes in NFA to keep their NFAs on a sustainable path.

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Document Object Identifier (DOI): 10.3386/w18380

Published: Durdu, C. Bora & Mendoza, Enrique G. & Terrones, Marco E., 2013. "On the solvency of nations: Cross-country evidence on the dynamics of external adjustment," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 762-780.

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