Fiscal Policy, Foresight and the Trade Balance in the U.S

• Authors: Luca Gambetti.
• BSE Working Paper: 110000 | September 15
• Keywords: current account , fiscal policy , Structural factor model , twin deficits , trade deficit , Mundell-Fleming
• JEL codes: C32, E32, E62
• current account
• fiscal policy
• Structural factor model
• twin deficits
• trade deficit
• Mundell-Fleming

This paper investigates the effects of fiscal policy on the trade balance using a structural factor model. A fiscal policy shock worsens the trade balance and produces an appreciation of the domestic currency but the effects are quantitatively small. The findings match the theoretical predictions of the standard Mundell-Fleming model, although fiscal policy should not be considered one of the main causes of the large US external deficit. My conclusions differ from those reached using VAR models since the fiscal shock, possibly due to fiscal foresight, is nonfundamental for the variables typically used in open economy VARs.