We describe unique aspects of microstates-they are less diversified, suffer from lumpiness of investment, they are geographically at the periphery and prone to natural disasters, and have less access to capital markets-that may make the current account more vulnerable, penalizing exports and making imports dearer. After reviewing the "old" and "new" view on current account deficits, we attempt to identify policies to help reduce the current account. Probit regressions suggest that microstates are more likely to have large current account adjustments if (i) they are already running large current account deficits; (ii) they run budget surpluses; (iii) the terms of trade improve; (iv) they are less open; and (v) GDP growth declines. Monetary policy, financial development, per capita GDP, and the de jure exchange rate classification matter less. However, changes in the real effective exchange rate do not help drive reductions in the current account deficit in microstates. We explore reasons for this and provide policy implications.
terms of trade shocks adjust their CA, with the goal of drawing policy lessons for microstates.
The paper makes two main contributions to the policy debate on CAadjustments:
It differentiates between microstates and other states, making it possible to draw conclusions specific to smaller economies. It looks at sustained reduction of the CA deficit rather than just abrupt and short-lived fluctuations.
The remainder of the paper is structured as follows: After describing the evolution of CAs in microstates ( Section II ), we analyze their unique characteristics
Mr. Ruben V Atoyan, Mr. Jonathan F Manning, and Jesmin Rahman
implying a slow pace.
Besides the pace of adjustment, the composition of adjustment has been different across countries. For emerging Europe, both import compression and export recovery played a part in CAadjustment ( Figure 3 ). A sudden stop or withdrawal of foreign capital halted financing and choked demand for imports ( Figures 3 and 4a ). At the same time, wage adjustment in the tradable sector and growth in trading partners helped with exports. In EZ periphery, imports contracted, though not as much as in emerging Europe, and exports did not provide