The Unassuming Economist

From a new IMF working paper by Davide Furceri and Aleksandra Zdzienicka:

“We provide new evidence of the existence of the “twin deficits” in developing economies. Using unanticipated government spending shocks for an unbalanced panel of 114 developing economies from 1990 to 2015, we find that a one percent of GDP unanticipated improvement in the government budget balance improves, on average, the current account balance by 0.8 percentage point of GDP. This effect is substantially larger than usually found in the literature using standard measures of fiscal policy changes such as the CAB. This finding has important policy implications as for a given target of external adjustment less fiscal consolidation is required than normally assumed.

Beyond this average effect lies some heterogeneity, both across states of the business cycle and across countries. The effect tends to be larger: (i) during recessions; (ii) in countries that are more open to trade; (iii) that have less flexible exchange rate regimes; and (iv) with lower initial public debt-to-GDP ratios. This heterogeneity has far-reaching implications for policymakers in deciding the magnitude of the fiscal adjustment needed to address external imbalances.”