Fiscal policy and the current account new evidence from four East Asian countries

Abstract

The long-run relation and short-run dynamics of fiscal policy and current account is examined using time-series data on four East Asian economies – South Korea, Malaysia, Singapore and Thailand. The purpose of the study is to test the validity of two alternative views on budget deficits – the Ricardian and Keynesian theories. According to Ricardians, given the path government spending, a rise in budget deficits has no effect of national savings, investment and the current account. In contrast, Keynesian theory suggests that such tax cuts reduce national savings and result in current account deficits. Empirical results based on cointegration model and Error Correction Model (ECM) over 1975–2008 are broadly consistent with the Ricardian view.

Keywords:

• budget deficits
• current account
• Ricardian theory
• Keynesian theory

JEL Classification:

• B22
• E12
• E62
• F41
• H62

Notes

¹A textbook treatment of the theoretical relations is found in Abel et al. (2011), chapters 5 and 15.

²Earlier literature includes Darrat (1988), Bernheim (1989), Congressional Budget Office (1989), Miller and Russek (1989), Enders and Lee (1990), Kearney and Monadjemi (1990), Zietz and Pemberton (1990), Arora and Duma (1993), Seater (1993), Mohammadi and Skaggs (1996), Mohammadi (2000, 2004), Holmes (2006) and Roubini and Kim (2008), among others.

³We proxy nominal interest rates by the yield on national housing bond for Korea; by the 3-month treasury bill rates for Malaysia and Singapore; and by the yield on government bonds for Thailand.

⁴This includes the current account for Malaysia from 1975 to 1998 and Singapore from 1975 to 1994; budget deficits for Korea from 2001 to 2007, Malaysia from 2000 to 2003, Thailand from 1976 to 1992; government expenditures for Malaysia from 1975 to 1990, Singapore from 1975 to 2008, Thailand from 1976 to 1992; and real GDP for Malaysia from 1975 to 1990 and for Singapore from 1975 to 2002.

⁵The results are available upon request.