The Modality of Fiscal Consolidation and Current Account Adjustment
27 Pages Posted: 4 Aug 2015
Date Written: July 31, 2015
Abstract
In this paper we argue that supply-side adjustments (i.e. the reallocation of productive resources between the traded and non-traded sectors) can be an important determinant of the output costs of current account adjustment. The argument relies on the fact that tax evasion is more prevalent in the non-traded sector, which is dominated by services and the self-employed. Heavy reliance on tax-based fiscal consolidations induces a reallocation of economic activity towards the non-traded sector, thus requiring a larger decline in domestic absorption (and output) per unit of improvement in the current account balance. Using IMF data for the period 1980-2011 we find that budget consolidations which rely more on tax increases than on spending decreases will be associated with larger output costs per unit of current account improvement.
Keywords: current account adjustment, fiscal consolidation, sacrifice ratio, tax evasion
JEL Classification: E620, F320, F410
Suggested Citation: Suggested Citation