Twin Deficits, Openness and the Business Cycle

26 Pages Posted: 2 Jun 2008

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Gernot J. Müller

University of Tuebingen - Department of Economics

Date Written: September 2007

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 Classification: E32, F41, F42

Suggested Citation

Corsetti, Giancarlo and Müller, Gernot J., Twin Deficits, Openness and the Business Cycle (September 2007). CEPR Discussion Paper No. DP6492, Available at SSRN: https://ssrn.com/abstract=1138956

Giancarlo Corsetti (Contact Author)

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

via Ostiense 139
Rome, 00154
Italy
+39 06 5737 4056 (Phone)
+39 06 5737 4093 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Gernot J. Müller

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

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