Composition and growth effects of the current account: a synthesized portfolio view

This paper analyzes a useful accounting framework that breaks down the current account to two components: a composition effect and a growth effect. We show that past empirical evidence, which strongly supports the growth-eect as the main driver of current account dynamics, is mis- conceived. The remarkable empirical success of the growth eect 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 previous ndings that the portfolio share of net foreign assets to total assets is constant in a country, both our theoretical and empirical results support a highly persistent process or a unit root process, with some countries displaying a trend. Finally, we reestablish the composition effect as the quantitatively dominant driving force of current account dynamics in the past data.