In his formal discussion of the same paper, Jacob Frenkel agrees with this point and further suggests that even if a current account deficit cannot be traced to a fiscal deficit, it might still be a symptom of bad policies, since it might have arisen because the incentives affecting the private sector's saving and investment decisions were distorted by an inappropriate structure of taxes and subsidies or by inappropriate monetary policy.
Frenkel praises the breadth of Helliwell's paper, but stresses that more detail is necessary to establish the nature of the links between fiscal policy and the external balance. Knowing the change in the budget deficit is not enough, he believes. It is necessary to ask what type of spending or taxes changed because, for example, it is im- portant to know whether changes in spending affected markets for traded or nontraded goods or whether tax changes affected labor or capital. Because the composition of spending and taxes is so im- portant, it is not surprising that it is so difficult to establish a simple correlation between changes in the overall budget deficit and the current account deficit. Because Helliwell assumes that the increase in the deficit was caused by a change in spending when tax cuts were also important, Frenkel finds his empirical results somewhat suspect, especially given that the models used by Helliwell suggested much less of a dollar appreciation than actually occurred. Clearly, states Frenkel, something else might be going on that is not explained by Helliwell's approach.
Frenkel notes the importance of Helliwell's conclusion that do- mestic policies alone are incapable of curing the U.S. current account deficit. This suggests that higher growth abroad is also required, which further suggests the need for international coordination. Fren- kel states that until recently, G-7 coordination was governed by the "tango principle." The U.S. was to reduce its budget deficit and others were to replace its stimulative effect by engaging in their own stimulative policies, just as one partner's foot precisely replaces the other's in dancing the tango. This was appropriate, says Frenkel, when there was a fear of the world sinking into recession, but with the G-7 partners operating at almost full capacity, accelerating in- flation is now the greater danger and the tango principle is no longer appropriate. However, coordination still provides a helpful frame- work through which governments can take actions that are in their own interests but which they might not do without the cooperation and peer pressure of other governments. Such actions include struc- tural reforms designed to improve productive capacity. In any case, the “tango principle" assumed that fiscal policies were much more Penner flexible than they are in fact. Frenkel believes that it is probably just as well that they are inflexible or else countries would be tempted to use them much more for fine tuning, which frequently turns out badly.

 

the model? If not, it may be that this significant appreciation did not affect the current account for many other reasons still to be explored. Another reason for regarding the empirical results with a grain of salt is that the simulations all assume that a rise in government spending caused the budget deficit in the United States. But, in fact, much of the deficit arose from a fall in taxes. If you believe that the source of the deficit matters significantly, additional analysis may be merited. Let me turn now to the policy discussion. The paper makes two key policy statements. First, domestic policy alone is not likely to remove the external deficit entirely, and therefore higher growth in countries outside of North America is required. Because the simu- lations suggest that monetary policy has little effect on growth, pre- sumably it is fiscal stimulus that is required. Up to two years ago, or even a year ago, the strategy of G-7 coordination, at least in terms of some of the pronouncements, could be called the "tango princi- ple." Namely, as the U.S. decreases its budget deficit, surplus coun- tries like Germany and Japan should increase their spending or budget deficit to prevent the world spinning into a big recession. As one foot goes back it makes room for the other foot to step in and the tango continues. This is the rationale for the view that "as we with- draw, they must expand." This leads to two concerns. The first and foremost is whether this is what the world needs today. The world is now operating close to full capacity, and the most serious problems are the shortage of global savings and the threat of inflation. It is not by chance that the G-7 are no longer talking about the tango principle. Now, they talk instead about joint action. This means that as the U.S. brings down its budget deficit, surplus countries are using the momentum of coordination to carry out actions that are in their own interests, such as structural reforms. The need to promote global world savings is based on the recognition that the debt situation as well as the emerging devel- opments in Eastern Europe call for additional financial resources if investment is not to be crowded out. Second, the tango principle presumes a tremendous degree of flex- 66 The Great Fiscal Experiment ibility in fiscal policy. If there is one lesson from the past few years, it is that fiscal policy is not a flexible instrument that can be used as precisely as dancing the tango. Typically, if you try to use it you will probably find yourself fighting the previous war because there are significant lags between the time of recognition that a fiscal action is needed and the time that the fiscal action is implemented. Fur- thermore, the effects of fiscal policy on the economy work only after long lags. Maybe this is a good thing, because if fiscal policy were a much more flexible policy instrument we might have been tempted