And Macroeconomic Imbalances — Fiscal Policy

This inflow of foreign capital often appreciates the currency, making exports expensive and imports cheap, which leads to a Current Account Deficit . This phenomenon, where a budget deficit leads to a trade deficit, is known as the Twin Deficits Hypothesis . 3. Sovereign Debt and Financial Instability

There is a strong accounting link between a government’s budget and its trade position. Fiscal Policy and Macroeconomic Imbalances

If investors lose confidence in a government’s ability to repay, capital flight occurs. This can trigger a currency crisis, as seen in the Eurozone debt crisis, where fiscal imbalances in one nation threatened the stability of the entire monetary union. 4. The Role of Automatic Stabilizers This inflow of foreign capital often appreciates the

The most direct impact of fiscal policy is on . Sovereign Debt and Financial Instability There is a

Persistent fiscal deficits lead to a rising debt-to-GDP ratio. While debt can fund productive investment, excessive borrowing creates two major imbalances:

Conversely, aggressive austerity (sharp spending cuts or tax hikes) during a downturn can collapse demand, leading to high unemployment and output gaps. 2. The External Imbalance: The "Twin Deficits"