Fiscal Policy and the Current Account

Abstract

Deficits and trade Jose Vinals Does the balance of payments act as an external constraint on the design of domestic economic policy? In practice, most governments believe it does. Yet popular discussion is sometimes confused. This paper begins by evaluating the nature of the external constraint and the extent to which it can adequately be measured by the current account of the balance of payments. It is often argued that a fiscal expansion will increase employment. It is also widely held that a fiscal expansion necessarily leads to a deterioration of the current account. While these propositions may hold in specific circumstances, neither is generally true. The theoretical basis of the two propositions is examined and compared with recent international experience when important changes in fiscal stance occurred. The popular presumptions are confirmed by recent experience in the US, the UK, and Germany; but France is a counterexample to the first and Spain to the second. The important policy implication is that one can identify, both in theory and in practice, clear circumstances in which expansionary fiscal policy is appropriate and will not be thwarted by external considerations.