On the relationship between the current account and the fiscal balance: The case of Canada

Abstract

This paper uses an Autoregressive Distributed Lag model to examine the long run and short run relationship between the current account and the fiscal balance, as well as other determinants, using Canadian quarterly data from 1981 to 2018. The results indicate that there is a long-run cointegrating relationship between the current account and the fiscal balance, investment, and private credit. Moreover, the relationship between the current account and the fiscal balance is positive in the long-run, thus providing support for the Keynesian Hypothesis of the fiscal balance driving the current account. Specifically, a one percentage point rise in the fiscal balance to GDP ratio yields a 0.43 percentage point rise in the current account as a percent of GDP. This positive relationship is present in the short-run as well. Finally, the findings from the error correction model yield a speed of adjustment of 0.225, hence 22.5% of the long-run adjustment in the current account occurs next period.