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External and Budget Deficits in Developing Countries

Author

Listed:
  • Foued Chihi
  • Michel Normandin

Abstract

This paper documents and explains the positive comovement between external and budget deficits for several developing countries. First, the covariance estimated from post-1960 time-series data is numerically positive for each of the 24 countries and statistically significant for almost all cases. This is consistent with previous findings obtained from panel regressions. Second, the empirical covariance is close to that predicted from a tractable small open economy, overlapping generation model with heterogeneous goods. Also, the predicted covariance is induced by shocks which are closely related to internal conditions such as domestic resources and fiscal policies, and to a much lesser extent to external conditions such as the world interest rate, real exchange rate, and terms of trade. This structural analysis explaining the joint behavior of external and budget deficits sharply contrasts with earlier reduced-form studies characterizing the individual behavior of either the external deficit or budget deficit.

Suggested Citation

  • Foued Chihi & Michel Normandin, 2008. "External and Budget Deficits in Developing Countries," Cahiers de recherche 0819, CIRPEE.
  • Handle: RePEc:lvl:lacicr:0819
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    References listed on IDEAS

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    More about this item

    Keywords

    Covariance decomposition; dynamic responses; internal and external conditions; restricted vector autoregression; small open economy; overlapping generation model with heterogeneous goods;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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