Testing for Causality between the Foreign Direct Investment, Current Account Deficit, GDP and Total Credit: Evidence from G7

Abstract

In this study, countries were analyzed between 1990 and 2011 in order to determine whether a causal relationship exists among current account deficit, GDP, foreign direct investment, and total credits of G7. Analysis took into account the cross-sectional dependence and was applied to test the causality among the variables form the panel. Firstly, panel unit root tests were used for determining stationary of variables. As a result of the panel unit root tests, it was found that GDP and foreign direct investment have a stationary structure and that total credits and current account deficit contain unit root. In order to see whether there is a long-term relationship among the variables or not, the panel co-integration test was used. As a result of the test, it was concluded that there is a co-integration relationship among the series. The possibility of a causal relationship was analyzed among the variables using the causality test developed by Elena Ivona Dumitrescu and Christophe Hurlin (2012). Results of the analysis showed a unidirectional causal relationship from current account deficit and foreign direct investment to GDP. Bidirectional causality was found between current account deficit and total credits. Finally, a unidirectional relationship was found from foreign direct investment to current account deficit and total credits.

Key words: Current account deficit, Foreign direct investment, GDP, Credit, Panel co-integration and causality, G7.
JEL: F21, F30, F43, C33.