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 journalArticle

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 pages22
JournalCuadernos de Economia (Spain)
Volume41
Issue number117
Publication statusPublished - 2018

Fingerprint

External balance
Long-term relationships
Causality
Euro zone
Twin deficits
External imbalances
Fiscal
Financial crisis
Finland
Spain
Currency
Government
Fiscal policy
Capital flows
Public finance

Cite this

@article{bbff35387f91445ab9cc3501aeac953d,
title = "Causality and the long-term relationship between external balance and public balance in the Eurozone",
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.",
author = "Carrasco, {Carlos A.} and Adrian Hernandez-Del-Valle",
year = "2018",
language = "English",
volume = "41",
pages = "275--290",
journal = "Cuadernos de Economia (Spain)",
issn = "0210-0266",
publisher = "Elsevier Espana",
number = "117",

}

Causality and the long-term relationship between external balance and public balance in the Eurozone. / Carrasco, Carlos A.; Hernandez-Del-Valle, Adrian.

In: Cuadernos de Economia (Spain), Vol. 41, No. 117, 2018, p. 275-290.

Research output: Contribution to journalArticle

TY - JOUR

T1 - Causality and the long-term relationship between external balance and public balance in the Eurozone

AU - Carrasco, Carlos A.

AU - Hernandez-Del-Valle, Adrian

PY - 2018

Y1 - 2018

N2 - 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.

AB - 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.

M3 - Article

VL - 41

SP - 275

EP - 290

JO - Cuadernos de Economia (Spain)

JF - Cuadernos de Economia (Spain)

SN - 0210-0266

IS - 117

ER -