Cyclical Reaction of Fiscal Policy and its Relationship with the Current Account Balance

Previous empirical studies aiming to verify the relationship between the current account (CA) and government expenditures have produced mixed results across regions and countries. In this study, we investigate whether cyclicality affects this relationship, based on a sample of 51 countries and using quarterly and annual data from 2002Q1 to 2018Q4. We use a structural panel vector autoregression model (Pedroni, 2013) to analyze the relationship between the CA and aggregate and disaggregate government expenditures for different groups of countries. Our findings indicate that a negative impact on the CA due to aggregate government spending is only visible in countercyclical economies, suggesting the importance of cyclicality in explaining the dynamics of the present value model. However, cyclicality is not sufficient for explaining the link between disaggregate fiscal policy and the CA, due to substantial heterogeneity. A timeseries approach shows that subsidies play a significant role in the CA of Austria, Croatia, Spain, and Bolivia and that property income is a major CA determinant in countries with large external debts. Conversely, the largest components of public spending (compensation of employees, intermediate consumption, and social benefits) play a minor role.