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Twin Deficits, Openness, and the Business Cycle

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Author Info
Giancarlo Corsetti
Gernot J. Müller

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Abstract

In this article, 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 U.S. 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. The effect of spending shocks on the trade balance is contained, however, if an economy is not very open to trade. (JEL:F41, F42, E32) (c) 2008 by the European Economic Association.

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Article provided by MIT Press in its journal Journal of the European Economic Association.

Volume (Year): 6 (2008)
Issue (Month): 2-3 (04-05)
Pages: 404-413
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Handle: RePEc:tpr:jeurec:v:6:y:2008:i:2-3:p:404-413

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References listed on IDEAS
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  1. Heathcote, Jonathan & Perri, Fabrizio, 2002. "Financial autarky and international business cycles," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 601-627, April. [Downloadable!] (restricted)
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  2. Ravn, Morten O., 1997. "International business cycles in theory and in practice," Journal of International Money and Finance, Elsevier, vol. 16(2), pages 255-283, April. [Downloadable!] (restricted)
  3. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1994. "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, American Economic Association, vol. 84(1), pages 84-103, March. [Downloadable!] (restricted)
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  4. Soyoung Kim & Nouriel Roubini, 2004. "Twin Deficit or Twin Divergence? Fiscal Policy, Current Account, and Real Exchange Rate in the US," Econometric Society 2004 North American Winter Meetings 271, Econometric Society.
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  5. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1998. "Can sticky price models generate volatile and persistent real exchange rates?," Staff Report 223, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  6. Christopher J. Erceg & Luca Guerrieri & Christopher Gust, 2005. "Expansionary Fiscal Shocks and the US Trade Deficit," International Finance, Blackwell Publishing, vol. 8(3), pages 363-397, December. [Downloadable!] (restricted)
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  1. Martin Boileau & Michel Normandin, 2008. "Do Tax Cuts Generate Twin Deficits? A Multi-Country Analysis," Cahiers de recherche 0832, CIRPEE. [Downloadable!]
  2. Zeno Enders & Gernot J. Müller & Almut Scholl, 2008. "How do Fiscal and Technology Shocks affect Real Exchange Rates? New Evidence for the United States," CFS Working Paper Series 2008/22, Center for Financial Studies. [Downloadable!]
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