Twin deficits, twenty years laters

Location: New York
Author: Linda Ricci
Date: Friday, October 27, 2006

The latest edition of the Federal Reserve Bank of New York’s Current Issues in Economics and Finance, Twin Deficits, Twenty Years Later, is available.

Authors Leonardo Bartolini and Amartya Lahiri analyze the relationship between the increase in the size of fiscal deficits in a large number of industrialized and developing nations and the current account deficits of those countries. They do not find sufficient evidence to support the argument that cutting a nation’s fiscal deficit would significantly reduce its current account deficit.

The authors cite international data that every dollar of increase in fiscal deficit, accounted for primarily by tax cuts, goes in large measure to consumer savings rather than consumption. As a result, some of a nation’s need to borrow from abroad to finance its fiscal deficit is mitigated and its current account deficit is left relatively untouched.

According to the authors, when applied to the United States, this analysis suggests that even if the fiscal deficit—now about 2 percent of GDP—were fully erased, the nation’s current account deficit would improve by only a fraction of its current 7 percent of GDP.