Abstract
This paper analyzes the effect of the fiscal deficit on the current account deficit in the European Union during the period 1995-2018. The purpose is to examine to what extent an increase in government spending affects the deterioration of terms of trade and contributes to increasing external imbalances. Econometric methods for heterogeneous panel data models are used to analyse the existence of a long-run relationship between the fiscal deficit and the current account. The empirical findings indicate that the twin deficits hypothesis is not confirmed for the whole European Union, but only for a certain number of member states, where a long-run relationship still exists, confirming the impact of the fiscal deficit on the current account.
Highlights
We present the results of the econometric analysis of the impact of the fiscal deficit on the current account deficit in all member states of the European Union over the period 1995-2018
Relying on the conclusions about the cross-section dependence and the level of integration, further econometric analysis relates to testing the cointegration between fiscal deficit and the current account
In terms of the twin deficit hypothesis, which is confirmed in Slovakia, Hungary, Cyprus, Estonia, Latvia and Bulgaria, the results indicate that the long-run relationship between the fiscal balance and the current account was negative in countries that had current account deficits above 5% of GDP (Cyprus, Estonia and Latvia), while in other countries was positive (Slovakia, Hungary and Bulgaria) (Table 1A)
Summary
The objective of this research is to provide a deeper insight on the effect of fiscal deficit on current account balance in European countries
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