The Current Account, Fiscal Policy and Medium Run Income Determination

Abstract

This paper presents a new framework for analysing the simultaneous determination of current account imbalances and the path of national income. Using standard macroeconomic behavioral relationships, it first examines how and why current account deficits matter by investigating links between domestic consumption, government spending, output, saving, investment, interest rates and capital flows. Central to the model is the distinction between aggregate output and expenditure that enables dissection of the effects of discretionary fiscal policy on the current account and national income. The framework yields results relevant to the 'twin deficits' hypothesis that are contrary to those of standard models.