Twin deficits: squaring theory, evidence and common sense

Temporary and permanent government spending in an open economy: some evidence for the United Kingdom

Giancarlo Corsetti and Gernot Müller

Economic Policy, 2006, vol. 21, issue 48, 598-638

Abstract: OPENNESS AND FISCAL PERSISTENCESimple accounting suggests that shocks to the government budget move the current account in the same direction, and this ‘twin deficits’ intuition leads many observers to call for fiscal consolidation in the US as a necessary measure to reduce the large external imbalance of this country. The response of other macroeconomic variables to budget developments, however, has important implications for ‘twin deficits’ and for this policy prescription. Focusing on the international transmission of fiscal policy shocks via terms of trade changes, we show that the likelihood and magnitude of twin deficits increases with the degree of openness of an economy, and decreases with the persistence of fiscal shocks. We take this insight to the data and investigate the transmission of fiscal shocks in a vector autoregression (VAR) model estimated for Australia, Canada, the UK and the US. We find that in less open countries the external impact of shocks to either government spending or budget deficits is limited, while private investment responds in line with our theoretical prediction. These results suggest that a fiscal retrenchment in the US may have a limited impact on its current external deficit.— Giancarlo Corsetti and Gernot J. Müller

Date: 2006
References: Add references at CitEc
Citations: View citations in EconPapers (168)

Downloads: (external link)
http://hdl.handle.net/10.1111/j.1468-0327.2006.00167.x (application/pdf)
Access to full text is restricted to subscribers.

Related works:
Working Paper: Twin Deficits: Squaring Theory, Evidence and Common Sense (2005)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:oup:ecpoli:v:21:y:2006:i:48:p:598-638.

Access Statistics for this article

Economic Policy is currently edited by Ghazala Azmat, Roberto Galbiati, Isabelle Mejean and Moritz Schularick

More articles in Economic Policy from CEPR, CESifo, Sciences Po Contact information at EDIRC., CES Contact information at EDIRC., MSH Contact information at EDIRC.
Bibliographic data for series maintained by Oxford University Press ().