Current account and real effective exchange rate dynamics: the role of non-linear dynamics in Brazil
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2024-09
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Current account imbalances significantly impact economic policy, with sharp exchange rate movements often causing disruptions. Hamilton’s [1989] Markov Switching Model introduced a framework for analyzing such dynamics. Few papers have used non-linear multivariate models to study current accounts and real effective exchange rates. This paper documents the existence of non-linearity by estimating a Markov Switching VECM and showing its superiority against a linear benchmark for the Brazilian economy in the period of inflation target and dirty floating regime. The monthly frequency and the sample cover the period from 1999-2 to 2024-3. Two regimes were identified. One regime is related to crisis events and the other to tranquil periods. Both real exchange rate and current account dynamics differ across regimes highlighting the necessity of modelling nonlinearity.