Causality and the long-term relationship between external balance and public balance in the Eurozone

Carlos A. Carrasco, Adrian Hernandez-Del-Valle

Research output: Contribution to journalArticlepeer-review

Abstract

After the beginning of the financial crisis, European external imbalances – mainly in the southern countries – were explicitly or implicitly linked to the behaviour of the public finances under the so-called twin deficits hypothesis. At a theoretical level, a worsening of a government’s budgetary balance exerts upward pressure on real interest rates, which attracts capital flows –because of the relatively higher returns– resulting in an appreciation of the domestic currency and a worsening of external balances. In this article, we analyse the causality and long-term relationship between external balance and some fiscal variables for a set of ten Eurozone countries. According to our results, there is no evidence of a common causality pattern between the public balance and the external balance among different groups of Eurozone countries. In addition, when the analysis is carried out at individual level, only Spain and Finland present a long-term relationship between fiscal variables and the external balance. However, these relationships do not behave as predicted by the twin deficits hypothesis. These results call into question those symmetrical fiscal policies aimed (explicitly or implicitly) at correcting external imbalances in these countries.
Original languageEnglish
Pages (from-to)275-290
Number of pages16
JournalCuadernos de Economia (Spain)
Volume41
Issue number117
DOIs
Publication statusPublished - 2018

Bibliographical note

Funding Information:
This work was supported by the Consejo Nacional de Ciencia y Tecnología (CONACyT, Mexico) under the grant for Postdoctoral Researchers at the Instituto Politécnico Nacional and by the Sistema Nacional de Investigadores (SNI-CONACyT).

Publisher Copyright:
© 2018 Asociación Cuadernos de Economía.

Copyright:
Copyright 2019 Elsevier B.V., All rights reserved.

All Science Journal Classification (ASJC) codes

  • Economics, Econometrics and Finance(all)

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