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Rapid Current Account Adjustment following Terms of Trade Shocks : Are Microstates different

We describe the stylized facts of current account adjustments following negative terms of trade shocks, distinguishing between micro-states and other nations, because the former have certain characteristics—such as being less diversified, at the geographic periphery, subject to natural disasters and have less access to capital markets— that potentially make the current account more vulnerable, penalizing exports and making imports dearer. Using probit regressions, we show that countries 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 REER depreciates; (iv) the terms of trade improve; (v) they are less open; and (vi) GDP growth declines. There is evidence that monetary policy, financial development, per capita GDP, and the de jure exchange rate classification matter less. In micro-states, fiscal policies are important drivers in reducing the current account deficit, but not the REER. We explore reasons for that.