Fiscal Policies, External Deficits, and Budget Deficits

This paper studies the effects of fiscal policies on external and budget deficits. From a tractable small open-economy, overlapping-generation model, the effects are measured by the responses of the external deficit to an increase in the budget deficit due to a tax-cut. The responses are positively affected by the birth rate and the degree of persistence of the budget deficit. Empirical results for the G7 countries over the post-1975 period reveal that the values of birth rate are small for all, but one, countries; but the responses of external and budget deficits are substantial and persistent for most countries. In particular, the fiscal policy has the most important effects on the external deficits for Canada, Japan, and the United States; somewhat smaller impacts for France, Germany, and the United Kingdom; and negligible effects for Italy.