From CAB to CAAB? correcting indicators of structural fiscal positions for current account imbalance : economic papers 442, April 2011

In the past decade, a series of EU countries have witnessed absorption booms and growing current account deficits as a result of falling risk premia and rapid financial integration. At the same time, fiscal policy in those same countries has not been leaning against the wind effectively so as to contain boom-bust dynamics. This paper addresses the question whether buoyant temporary revenues during absorption booms contributed to excessive complacency by policy-makers and an insufficiently counter-cyclical response of fiscal policy. The paper shows that standard approaches for adjusting budget balances for the cycle could miss part of the temporary revenues accruing during absorption booms and that, in some instances, this could have mattered substantially for a proper assessment of structural fiscal positions. The paper also shows by means of DSGE model simulations that targeting a proper indicator of the underlying (structural) fiscal balance could have contributed substantially to the containment of macroeconomic imbalances and to avoiding boom-bust dynamics. The findings have implications for the conduct of discretionary fiscal policy and the design of fiscal rules and multi-annual fiscal frameworks.