Testing for current account sustainability under assumptions of smooth break and nonlinearity

In this paper we reexamine the current account sustainability under assumptions of smooth break and nonlinearity for nine European countries. We test for the null hypothesis of a unit root of the current account-GDP ratio against the alternative hypothesis that encompasses smooth break, size nonlinearity and sign asymmetry at the same time. For this purpose, we propose a battery of new test statistics and provide their critical values via Monte Carlo simulations. Our results show that the breaks alone can account for rejection of the null hypothesis of a unit root, although the evidence in support of the current-account sustainability is not sufficiently strong (only for Australia, the Czech Republic and New Zealand). Moreover, the evidence in favor of the current-account sustainability has been increased (i.e., Australia, Belgium, the Czech Republic, Finland, New Zealand, Norway, Ireland and Portugal) after taking account of size nonlinearity and structural break at the same time. Finally, for Finland, New Zealand and Ireland, the speed of mean reversion of the current account-GDP ratios is dependent not only upon the absolute deviation from the equilibrium, but also upon the sign of the shock.