Fiscal Policy and the Current Account: What do Capital Controls Do?

Abstract

The formulation of fiscal policy targets to restore external balance is becoming increasingly important as a condition in World Bank loans, not to mention IMF standby arrangements. Differing amounts of emphasis have been placed on the composition of government spending and the method of deficit finance in particular country situations. The paper suggests that in countries with unrestricted capital inflows and outflows, conditionality should focus on reducing the import component of government expenditure, rather than the amount of public sector borrowing abroad. In countries with capital controls on private external borrowing, on the other hand, fiscal targets should limit the amount of public sector borrowing, rather than attempting to shift the composition of government spending. This simple rule should help those involved in establishing a relatively small number of fiscal policy guidelines. [321]