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Fiscal policy and external adjustment: New evidence

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  • Bouakez, Hafedh
  • Chihi, Foued
  • Normandin, Michel

Abstract

Relatively little empirical evidence exists about countries' external adjustment to changes in fiscal policy and, in particular, to changes in taxes. This paper addresses this question by measuring the effects of tax and government spending shocks on the current account and the real exchange rate in a sample of four industrialized countries. Our analysis is based on a structural vector autoregression in which the interaction of fiscal variables and macroeconomic aggregates is left unrestricted. Identification is instead achieved by exploiting the conditional heteroscedasticity of the structural disturbances. Three main findings emerge: (i) the data provide little support for the twin-deficit hypothesis, (ii) the estimated effects of unexpected tax cuts are generally inconsistent with the predictions of standard economic models, except for the US, and (iii) the puzzling real depreciation triggered by an expansionary public spending shock is substantially larger in magnitude than predicted by traditional identification approaches.

Suggested Citation

  • Bouakez, Hafedh & Chihi, Foued & Normandin, Michel, 2014. "Fiscal policy and external adjustment: New evidence," Journal of International Money and Finance, Elsevier, vol. 40(C), pages 1-20.
    • Handle: RePEc:eee:jimfin:v:40:y:2014:i:c:p:1-20
    DOI: 10.1016/j.jimonfin.2013.08.019
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    Cited by:

    1. Bouakez, Hafedh & Eyquem, Aurélien, 2015. "Government spending, monetary policy, and the real exchange rate," Journal of International Money and Finance, Elsevier, vol. 56(C), pages 178-201.
    2. Bernhard Herz & Stefan Hohberger, 2013. "Fiscal Policy, Monetary Regimes and Current Account Dynamics," Review of International Economics, Wiley Blackwell, vol. 21(1), pages 118-136, February.
    3. Normandin, Michel, 2011. "Déficits extérieur et budgétaire : jumeaux, petits cousins ou parfaits étrangers?," L'Actualité Economique, Société Canadienne de Science Economique, vol. 87(4), pages 407-443, décembre.

    More about this item

    Keywords

    Current account; Exchange rate; Government spending; Structural vector autoregression; Taxes; Twin deficits;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General
    • H60 - Public Economics - - National Budget, Deficit, and Debt - - - General

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