Tax and Spending Shocks in the Open Economy: Are the Deficits Twins?

29 Pages Posted: 9 Oct 2019

See all articles by Mathias Klein

Mathias Klein

German Institute for Economic Research (DIW Berlin)

Ludger Linnemann

University of Cologne - Department of Economics

Date Written: August 22, 2019

Abstract

We present evidence on the open economy consequences of US fiscal policy shocks identified through proxy-instrumental variables. Tax shocks and government spending shocks that raise the government budget deficit lead to persistent current account deficits. In particular, the negative response of the current account to exogenous tax reductions through a surge in the demand for imports is among the strongest and most precisely estimated effects. Moreover, we find that the reduction of the current account is amplified when the tax reduction is due to lower personal income taxes and when the government increases its consumption expenditures. Historically, a much larger share of current account dynamics has been due to tax shocks than to government spending shocks.

Keywords: tax policy, government spending, proxy-vector autoregressions, current account, twin deficits

JEL Classification: E32,E62,F41

Suggested Citation

Klein, Mathias and Linnemann, Ludger, Tax and Spending Shocks in the Open Economy: Are the Deficits Twins? (August 22, 2019). DIW Berlin Discussion Paper No. 1821 (2019). Available at SSRN: https://ssrn.com/abstract=3466057 or http://dx.doi.org/10.2139/ssrn.3466057

Mathias Klein (Contact Author)

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstra├če 58
Berlin, 10117
Germany

Ludger Linnemann

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany
+49-221-470-2999 (Phone)
+49-221-470-5077 (Fax)

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