The Relationship Between Chinese Fiscal Deficit And Current Account

The deterioration of government budget and current account are principal manifestations of global economic imbalances. Due to the widespread of current account deficit among developed countries and developing countries, the relationship between budget deficit and current account deficit received long-term and increasing concern. A mass of literatrue reveals that there is no consistent conclusion ranging from Keynes's absorption approach, IS-LM-BP model and Ricardian Equivalence Rule to Intertemporal Approach that applied in study of current account. In order to test the above theoretical models, all manner of variables, samples and research techniques are adopted and eventually to generate quite different outcomes, including positive or negative correlativity or no correlation between budget deficit and current account deficit. The study of the relationship between the two variables, as it were, has more to do with topic in empirical research than that in theoretical analysis.From 1980s, China's government budgets in most years are adverse balanced, especially in 1997 and 2009 respectively followed by the Asian financial crisis and the US subprime mortgage meltdown when active fiscal policy was applied for curb the deflation and the shortage of domestic effective demands so as to stimulate the economy. However, China's budget deficits enlarged together with continuous surplus of current account except several years, which differs from the tendency in developed countries. This existence of budget deficit and current account surplus for a long period makes me think through the following problem.First of all, is the relationship between budget deficit and current account more close to"two deficits"hypothesis or Ricardian Equivalence Rule? And then, are the influences in short term and long term from budget deficit to current account the same? And Given that budget deficit has an influence on current account, how does the former exerts effect on the latter? Furthermore, how much is budget deficit's contribution to the fluctuation of current account? Out of the field in public finance, are there other factors which have the probability to promote the surplus of current account?Aiming at resolving the above mentioned topics, this paper carries out a series of theoretical and empirical analysis. In the chapter of theoretical analysis, we illuminate every factor in the identity of current account systematically, clarify and generalize four correlation types between budget deficit and current account and the mechanism related as well as several supporting literature. The segment of empirical analysis can be divided into two parts as follows.On the one hand, we engage in static study. At first, we validate the identity of current account with OLS regression equation;After that, we turn our attention to the cyclical nature of the government budget and the current account. To investigate such a possibility more formally, we regress the government budget deficit on the cyclical components of output, to extract"cyclical"and"non-cyclical or structural"components of the government budget deficit. Next, we regress the structural government budget deficit constructed from the former regression and cyclical output on the current account.On the other hand, we adopt more variables interacted into dynamic model. Our basic identification scheme uses a vector auto-regression model in which the ordering of the variables is {Y, BD, CA, RIR, REER}1.Within the model, our main interests are the impulse responses of current account to the each variable shocks and the forecast error variance decomposition of the current account. In the end, we adjust the order of variables, or replace the original ones, if necessary, making up new vector auto-regression models so as to confirm the above conclusion.The findings reveal that, in China, an increase in the government budget deficit leads to a worsening of the current account,but the fluctuation of current account in the long run is not influenced by budget deficit. In a word, budget deficit cannot directly make effects on the current account. Nevertheless, the indirect effect stemmed from budget deficit cannot be neglect. In the long period, current account surplus could be regard as the result of excessive government expenditure and thus crowding-out effect of private investment.In addition, the transmission mechanism—an increase in budget deficit leads interest rate rise, then RMB will appreciates, and then current account will worsen—unable to come true in China. At the same time, there are certain institutional barriers against the rising of interest rate and exchange rate. These financial variables are not capable of balancing the current account owing to the blockage of capital movement at home and abroad. Therefore , it is advisable that government administration revise the expenditure policy in more consideration of the condition on private investment, not merely based upon the performance of macro-economy. And unlocking interest rate and exchange rate would be welcome. Only in this way could the effect of man-induced factors be weakened.