Fiscal Policy and the Current Account

In this paper, we use the VAR model to produce a first-ever estimate of the connection between fiscal policy and the current account in Israel in 1995-2010. We find that a positive shock of 1 percent of GDP in public consumption increases net imports by 0.6 percent of GDP on average, but in the short term only-up to two quarters. The fact that the near-term effect of the shock is far from zero indicates that, as has been estimated in the literature, individuals do not increase their personal savings in the present by the full increase in public consumption. The study also shows that the main pass-through mechanism from public consumption to net exports is the direct one, based on real demand, and not the pass-through mechanism powered by indirect effects such as the exchange rate, inflation expectations, or interest. Another finding is that the positive pass-through of public consumption to civilian import demand is the principal channel that leads to this outcome. These conclusions are of fiscal macroeconomic importance in understanding macroeconomic processes in recent years, in examining the planning of the government consumption framework, and in understanding the implications of both.