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Fiscal Rules and Twin Deficits: The Link between Fiscal and External Balances

Badinger, Harald and Fichet de Clairfontaine, Aurélien and Reuter, Wolf Heinrich (2015) Fiscal Rules and Twin Deficits: The Link between Fiscal and External Balances. Department of Economics Working Paper Series, 196. WU Vienna University of Economics and Business, Vienna.

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Abstract

This paper investigates the relationship between countries' fiscal balances and current accounts with an emphasis on the role of fiscal rules. The direct effect of fiscal policy on the current account via aggregate (import) demand is potentially amplified by indirect effects, materializing through interest rate effects and inter-generational transfers that reduce savings. On the other hand, the implied positive relation between fiscal and external balances is potentially attenuated by offsetting changes in savings through Ricardian equivalence considerations. We expect this attenuation effect to be stronger in countries with more stringent fiscal rules and test this hypothesis using a panel of 73 countries over the period 1985-2012. As previous studies we find a positive effect of fiscal balances on the current account, supporting the twin deficit hypothesis. However, the effect of fiscal balances on the current account depends on the stringency of fiscal (budget balance or debt) rules in place; it is reduced by one third on average and virtually eliminated for countries with the most stringent fiscal rules. (authors' abstract)

Item Type: Paper
Keywords: Twin Deficits / Fiscal Policy / Fiscal Rules / Current Account
Classification Codes: JEL E62, F32, F41
Divisions: Departments > Volkswirtschaft
Depositing User: Claudia Tering-Raunig
Date Deposited: 06 Jul 2015 10:57
Last Modified: 12 Sep 2016 15:44
FIDES Link: https://bach.wu.ac.at/d/research/results/72383/
URI: http://epub.wu.ac.at/id/eprint/4579

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