Fiscal Policy and the Current Account

Abstract

This paper examines the relationship between fiscal policy and the current account, drawing on a large sample of advanced, emerging, and low-income economies and using a variety of statistical methods: panel regressions, an analysis of large fiscal policy and current account changes, and panel vector autoregressions (VAR). On average, across estimation methods, a strengthening in the fiscal balance by 1 percentage point of GDP is associated with a current account improvement of about 0.3 percentage point of GDP. With our preferred estimation method (quarterly structural VAR using government consumption to identify fiscal policy shocks), the relationship is stronger, in the 0.3–0.5 range. The association is stronger in emerging markets and low-income countries; in economies that are more open to trade; and when the economy is somewhat overheated to begin with. The effect is, however, notably weaker during episodes of large fiscal policy and current account changes, suggesting that fiscal policy may have a more limited role in correcting large external imbalances.