The Fiscal Policy Implications of Balance of Payments Imbalances

The global financial and economic crisis and the euro-crisis in particular, which was grabbing headlines at the time of writing, demonstrate unmistakably that external imbalances can pose significant fiscal challenges. Although the nature of these challenges differs between deficit and surplus countries, they can be serious for both sets of countries. This chapter investigates these challenges and potential remedies more closely. Given the significant problems the current crisis has created for countries in the industrialised world, it focuses on advanced economies and addresses the following three questions: First, which fiscal challenges result from imbalances in countries' balance of payments? While much has been written about the fiscal challenges faced by deficit countries, this chapter will also investigate the more indirect fiscal risks faced by surplus countries. Second, how do countries adjust to such imbalances and what are the implications of these adjustment strategies for fiscal policy; what are the domestic distributional struggles associated with different adjustment strategies; and why is adjustment frequently delayed? Finally, the third section asks what countries can do to increase their readiness to confront emerging problems related to external imbalances early on