The Effect of External Positions on FX Misalignments: A study of the G10 countries applying the Macroeconomic Balance Approach

Abstract: The aim of this paper is to investigate if the macroeconomic balance approach will generate different misalignments whether net foreign assets or cumulative current account is applied. The dataset consist of the G10 countries and range from 1981 to 2011. The relevant determinants of the current account are found to be fiscal balance, population growth, net foreign assets, cumulative current account and trade integration. The cumulative current account is concluded to have a greater impact on the current account than net foreign assets, which in turn results in a larger misalignment when the cumulative current account is significantly high or low. It is impossible to conclude whether net foreign assets or the cumulative current account is a better proxy for the external position of a country. However, the cumulative current account does in some cases appear to provide results that seem more in line with reality using subjective judgment. Valuation effects could be seen as enhancing net foreign assets as a measure, but could also contribute to misleading implications of the state of an economy.