Connection between Exchange Rate and Balance of Payments Accounts: The Case of the Czech Republic

Relationships between nominal exchange rate, current account and financial account of balance of payments in the Czech Republic have been investigated in presented paper. Implemented cointegration analysis and vector error correction model suggest one pair of Granger causality. It has been discovered that change in current account balance Granger-causes change in financial account balance. This relationship has nature of two-way Granger causality, which means that reversed relationship holds as well. Other relatiohships implying Granger causality were not found. Error terms were significant only in regressions with both accounts as dependent variables, which imply that only these variables return to their long-term equilibria. Because increase in financial account surplus leads to decrease in current account surplus (or deepening the current account deficit), excessive liberalization of Czech financial system can lead to large capital inflow, jeopardizes current account sustainability and results in currency crisis in the Czech economy.