Working Paper: CEPR ID: DP6492
Authors: Giancarlo Corsetti; Gernot J. Müller
Abstract: In this paper, we study the co-movement of the government budget balance and the trade balance at business cycle frequencies. In a sample of 10 OECD countries we find that the correlation of the two time series is negative, but less so in more open economies. Moreover, for the US the cross-correlation function is S-shaped. We analyze these regularities taking the perspective of international business cycle theory. First, we show that a standard model delivers predictions broadly in line with the evidence. Second, we show that conditional on spending shocks the model predicts a perfect correlation of the budget balance and the trade balance. Yet, the effect of spending shocks on the trade balance is contained if an economy is not very open to trade.
Keywords: business cycle; fiscal policy; openness; twin deficits
JEL Codes: E32; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| budget surpluses (H62) | trade deficits (F14) |
| budget and trade balances (H69) | conditional on spending shocks (E62) |
| government spending shocks (E62) | joint deterioration of the budget and trade balances (H69) |
| fiscal expansions (E62) | joint deterioration of the budget and trade balances (H69) |
| government spending shocks (E62) | perfect correlation of budget balance and trade balance (F30) |
| technology shocks (D89) | negative relationship between budget balance and trade balance (F32) |