Research Discussion Paper – RDP 8813 The Fiscal Deficit and the Current Account: Twins or Distant Relatives?
December 1988
Abstract
Current account imbalances have in recent years become a concern of policy makers and public opinion in a number of countries. It is often argued that budget imbalances of the public sector are at the root of the current account imbalances. The aim of this paper is to provide a suitable framework for investigating the determinants of the current account and to use this framework to study the relationship between budget- and current-account imbalances. It is concluded that reactions of the private sector to goverment policies may partially, fully, or even more than fully offset the effects on the current account of budget consolidation efforts depending on the way in which fiscal policy is altered to achieve a reduction in the public sector's borrowing requirement. Simple correlations between fiscal deficits and the current account may be misleading, not only due to the presence of other shocks, but also because it matters how the deficit is changed.