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Fiscal policy and the current account: are microstates different?

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  • Yehenew Endegnanew
  • Charles Amo-Yartey
  • Therese Turner-Jones

Abstract

This article examines the empirical link between fiscal policy and the current account focusing on microstates defined as countries with a population of less than 2 million between 1970 and 2009. This article employs panel regression and Panel Vector Autoregression (PVAR) on 155 countries of which 42 are microstates. Panel regression results show that a percentage point improvement in the fiscal balance improves the current account balance by 0.4 percentage points of Gross Domestic Product (GDP). The real effective exchange rate has no significant impact on the current account in microstates but the coefficient is significant in the global sample. PVAR results show that an increase in government consumption results in real exchange appreciation, but the effect on the current account after an initial deterioration dies out quicker in microstates than in the global sample. The result implies that fiscal policy has little effect on the current account in microstates beyond its direct impact on imports. Overall, the results suggest that the weak relative price effects make the effect of fiscal adjustment on the current account much more difficult in microstates.

Suggested Citation

  • Yehenew Endegnanew & Charles Amo-Yartey & Therese Turner-Jones, 2013. "Fiscal policy and the current account: are microstates different?," Applied Economics, Taylor & Francis Journals, vol. 45(29), pages 4137-4151, October.
    • Handle: RePEc:taf:applec:v:45:y:2013:i:29:p:4137-4151
    DOI: 10.1080/00036846.2012.754542
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    1. Jacob Frenkel & Assaf Razin, 1996. "Fiscal Policies and Growth in the World Economy," MIT Press Books, The MIT Press, edition 3, volume 1, number 0262561042, April.
    2. Patrick A. Imam, 2008. "Rapid Current Account Adjustments: Are Microstates Different?," IMF Working Papers 2008/233, International Monetary Fund.
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