The analytic chapters were released yesterday.
- Chapter 3: Target What You Can Hit: Commodity Price Swings and Monetary Policy
- Chapter 4: Separated at Birth? The Twin Budget and Trade Balances
From Chapter 4:
How do changes in taxes and government spending affect
an economy’s external balance? Based on a historical analysis
of documented fiscal policy changes and on model simulations,
this chapter finds that the current account responds
substantially to fiscal policy—a fiscal consolidation of 1
percent of GDP typically improves an economy’s current
account balance by over a half percent of GDP. This comes
about not only through lower imports due to a decline in
domestic demand but also from a rise in exports due to
a weakening currency. When the nominal exchange rate
is fixed or the scope for monetary stimulus is limited, the
current account adjusts by as much, but the adjustment
is more painful: economic activity contracts more and the
real exchange rate depreciates through domestic wage and
price compression. When economies tighten fiscal policies
simultaneously, what matters for the current account
is how much an economy consolidates relative to others.
Looking ahead, the differing magnitudes of fiscal adjustment
plans across the world will help lower imbalances
within the euro area and reduce emerging Asia’s external
surpluses. The relative lack of permanent consolidation
measures in the United States suggests that fiscal policy
will contribute little to lessening the U.S. external deficit.
The analysis relies upon an empirical model that uses action based indicators of fiscal policy (see this post on how using such measures results in findings on expansionary contractions different from the Alesina-Ardagna (2010) results so beloved by some), as well as results from the IMF’s GIMF model. From the first approach, they obtain results that are not empirically dissimilar to the Chinn-Prasad [pdf] and Chinn-Ito [pdf] [pdf] studies.
From the conclusion of the chapter, some words that are relevant to the adherents to the expansionary fiscal contraction thesis, as applied to the United States:
…The contractionary effect of fiscal consolidation
is now well established, with consequent effects on
import demand, and this is something policymakers
cannot ignore—fiscal consolidation hurts. …
This doesn’t necessarily mean that one shouldn’t pursue fiscal consolidation; merely it reiterates that one has to be careful about how — and when — to implement the consolidation.