The Impact of the Budget Deficit on the Current Account Deficit
Menzie Chinn critiques the Bush administration's latest Snow job:
Econbrowser: The Debate over the Impact of the Budget Deficit on the Current Account Deficit: In a recent Washington Post article, Treasury Secretary Snow was quoted as follows:
Speaking to the International Monetary Fund, Snow repeated the U.S. position that ratcheting down big imbalances in trade and capital flows "cannot be anything other than a shared responsibility" because no one country caused them.
Interestingly, this assertion is much less nuanced than the Treasury Occasional Paper on the subject released at roughly same time. That study cited point estimates for the response of the current account to GDP ratio to a a budget balance to GDP ratio ranging from 0.1 (Erceg et al.) to 0.44 (IMF).
Since the study also cited the 0.13 coefficient Chinn and Prasad (2003), it seems only natural to discuss what Hiro Ito and I have discovered in our updating of these estimates to 200.... The updated point estimate is 0.20 -- for a pooled panel cross section regression (where the observations are 5 year averages of annual data). Our fixed-effects regression estimates... the industrial country point estimate of 0.40. The estimate is significantly different from zero at the 10% marginal significance level. Why is this point estimate so different from the pooled panel-time series estimate? The biggest impact likely arises from allowing each individual country to have a different constant....
Is the pooled estimate for appropriate? It depends upon the question one is asking. If one wants to know something about the average response for an industrial country's current account balance to changes in the budget balance, assuming a high degree of homogeneity across the countries, then this is the correct number. If, on the other hand, one is interested primarily in how the United States behaves, allowing it to have a country specific constant, then the fixed effects estimate is more relevant....
[T]he question of whether fiscal policy would be effective in reducing the current account imbalance of the United States is an open one.... I would assert the empirical evidence... is on the side of effects greater than 0.2.... [W]hen the coefficient is 0.4 (remarkably close to the OECD's Interlink model, and similar to that in other estimated macroeconometric models), 0.4 means that a 6% percentage point swing in the budget balance -- like the one that took place after 2001 -- would result in a 2.4 percentage point swing in the current account balance. Not enough to eliminate the deficit, but certainly enough to make a substantial impact...
Menzie, however, is kind, relative to what the Washington Post did to John Snow. It got medieval on him, by putting this headline atop his argument: "Don't Blame Just Us."
