Mr. Yehenew Endegnanew, Charles Amo-Yartey, and Ms. Therese Turner-Jones
This chapter examines the empirical link between fiscal policy and the current account focusing on microstates, defined as countries with a population of less than 2 million between 1970 and 2009. The extent to which fiscal adjustment can lead to predictable development in the current account remains controversial, with two competing views. The traditional view argues that changes in fiscal policy are associated with changes in the current account through a number of channels that are discussed in the literature review. The traditional view is challenged by the Ricardian equivalence principle, which states that an increase in budget deficit (through reduced taxes) will be offset by increases in private saving, insofar as the private sector fully discounts the future tax liabilities associated with financing the fiscal deficit, hence not affecting the current balance.
The recent global financial crisis has drawn renewed attention to the effectiveness of fiscal policy, as many countries implemented fiscal stimulus measures to boost economic activity. The effectiveness of fiscal policy is often assessed by the size of fiscal multipliers, which measure a change in output caused by an exogenous change in government spending or tax revenue. This chapter estimates fiscal multipliers for the Caribbean using quarterly data for 14 Caribbean countries,1 and investigates key determinants of the size of the multipliers. The results show that fiscal multipliers in the sample countries are modest, and that the high levels of trade openness and public debt account for their modest size.
This chapter concludes the analysis in this book with an agenda for moving the region forward, drawing on the discussions of preceding chapters and the accompanying empirical analyses. While a survey of current policies through the Caribbean suggests that there is plenty of work yet to do on the fiscal sustainability agenda, the lack of an economic recovery in the presence of high debt for many countries calls for action. While each country will need to tailor its specific strategy, we outline below some key elements that should be part of any medium-term framework that countries in the region may consider adopting. Already, some countries are responding to the need for action by independently selecting some elements of the menu proposed in this book and putting them in place to meet their debt reduction targets. These include some difficult and complex new institutional arrangements, such as Jamaica’s proposals for implementing a new fiscal rule.