combination is estimated by OLS. The final estimate is obtained by averaging across all the estimated regressions using a suitable criterion to select individual model’s weights. We use the Jackknife Model Averaging (JMA) estimator for non-nested and heteroscedastic models (Hansen and Racine, 2012) where the weights are chosen by minimizing a leave-one-out cross-validation criterion. In this way, a large number of variables can be included, while, at the same time, only single country estimation is performed (thus eliminating a heterogeneity-induced bias in the resulting parameter estimates of panel studies, Robertson and Symons, 1992, Pesaran and Smith, 1995). In total, we estimate between 6,475 and 9,948 different models, depending on the specification.

# **How sensitive is the Current Account Balance to individual factors?**

The baseline specification is estimated using the standard definition of the CAB. Model estimates are summarized in Table 2 below. The first column of Table 2 reports the baseline specification, and the subsequent columns provide various extensions. All variables have the expected signs and coefficient magnitudes are mostly in line with the empirical evidence in other countries.

- **An expansion in the credit stock decreases the current account balance** . A 10 percent of GDP expansion of the credit stock in a given year decreases the current account balance by 0.2 percent of GDP. Following post2002 easing of the borrowing constraints, fast credit expansion led to an increase in investment without a corresponding increase in private sector saving. To examine the credit effect further, Column 2 in Table 2 replaces the aggregate credit measure with credits to households and NFCs. While the estimated coefficients for other variables remain close to the baseline estimates, the credit variable estimates imply a relatively stronger reaction of the CAB to household credit expansion. This is expected given that corporate credit is associated with export growth (hence, potentially positive or less negative effect on CAB), compared to dominantly consumption-driven imports generated by household credit. Nevertheless, the effect on the CAB dynamics depends on the actual movements in the credit series that we look at in the following subsection.

- **Public expenditure contributes negatively to the CAB** . This is in line with the augmented inter-temporal models (see e.g. Bussiere et al, 2010) which imply that increases in fiscal expenditures and/or lower taxes may increase consumption and worsen the current account balance. The estimated effect is relatively small (a 10 percent of GDP increase in public expenditure decreases the current account balance by 0.2 percent of GDP), suggesting a limited effect of changes in the fiscal policy on the CA dynamics in the past. A regression with an alternative measure of the fiscal stance (public sector balance, Column 3) provides similar results.

- **A depreciation of the real effective exchange rate (REER) improves the CAB.** This is in line with the standard expenditure switching effect where REER depreciations make domestic goods relatively cheaper than foreign goods, inducing a switch away from foreign into domestic. The estimated coefficient suggests that this effect is modest, as a 10 percent depreciation of the REER improves the current account balance by 0.1 percent of GDP.

- **Faster real GDP growth than trading partners lowers the current account balance.** A 1 percent of additional growth in Turkey relative to its partners leads to a decline in the current account balance by 0.1 percent of GDP. As domestic demand, and consequently import demand, grows more rapidly than external demand for exports, the trade balance deteriorates, putting pressure on the current account. In this sense, the strong growth performance of the Turkish economy after 2002 (and above its trading partners) has contributed to CA deficits.

- **Higher relative income has a positive effect on the current account, though not statistically significant** . The current account deficits in the past were therefore partially related to the accumulation of capital goods and the process of the catching-up.

- **Greater trade openness improves the CAB.** The estimated effect of openness on the current account balance is positive as more open economies tend to have a larger tradable sector, and in line with the findings for developed and developing countries reported in Gruber and Kamin (2007) and Chinn and Ito (2007). This suggests that further trade integration of Turkey should have a beneficial effect on the current account.

- **Improvements in terms of trade have a positive effect on the CAB.** The estimated positive effect (0.01) on the current account balance signals a higher positive impact of the commodity price changes on domestic saving related to investment in the medium run, thus contributing to the current account improvements beyond the direct trade impact. The magnitude of the effect is relatively small compared to the emerging market literature suggesting lower vulnerability of Turkey to commodity price shocks, which can be attributed to a relatively high export diversification.

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