Comovements in budget deficits, money, interest rates, exchange rates and the current account balance: some empirical evidence

Most applications of structural VARs and cointegration to the study of the short- and long-run relationships among macroeconomic variables (in an open economy context) do not include budget deficits (or fiscal innovations) as one of the key variables. This paper attempts to rectify this omission by incorporating budget deficits into the analysis of the comovements in macroeconomic variables (budget deficits, money interest rates, exchange rates and the current account balance) in the short and long runs using a VAR approach. Empirical results suggest that a larger proportion of variations in the interest rate differential between financial centres as well as of variations current account balances of countries are accounted for by monetary innovations rather than by fiscal innovations. However, fluctuations in real exchange rates are better explained by fiscal innovations.