Composition and growth effects of the current account: A synthesizedportfolio view

This paper analyzes a useful accounting framework that breaks down the current account to twocomponents: a composition effect and a growth effect.We show that past empirical evidence, which stronglysupports the growth effect as the main driver of current account dynamics, is misconceived. The remarkableempirical success of the growth effect is driven by the dominance of the cross-sectional variation, which,under conditions met by the data, is generated by an accounting approximation. In contrast to previousfindings that the portfolio share of net foreign assets to total assets is constant in a country, both ourtheoretical and empirical results support a highly persistent process or a unit-root process, with somecountries displaying a trend. Finally, we reestablish the composition effect as the quantitatively dominantdriving force of current account dynamics in the past data.[...]