Is the US current-account deficit sustainable? The importance of structural breaks in testing sustainability

This paper improves the test for deficit sustainability developed by Hatzinikolaou and Simos (2013, henceforth HS) by taking into account structural breaks when deriving critical values for the test. Using quarterly data on the US current-account deficit, 1947.1-2012.2, we find that taking into account a structural break when testing for cointegration and when estimating a Box-Jenkins model for the derivation of the critical values renders the HS test more powerful than when ignoring the break. Thus, although HS failed to reject sustainability using their full sample period, 1947.1-2010.1, with the updated sample we can reject sustainability at the 10% level.