Twin deficits and the Feldstein-Horioka puzzle: a comparison of the EU member states and candidate countries

Aristovnik, Aleksander and Djurić, Sandra (2010): Twin deficits and the Feldstein-Horioka puzzle: a comparison of the EU member states and candidate countries.

Abstract

The paper’s main objective is to investigate the empirical link between the fiscal balance and the current account (i.e. the twin deficits phenomenon). The paper focuses on the EU member states and candidate countries which are according to their different (e.g. historical, political, economical and geographical) characteristics divided into two major groups, i.e. old EU member states (EU15) and new EU member states and candidate countries (EU12+3) in the 1995-2008 period. Additionally, the importance of the so-called Feldstein-Horioka puzzle in the considered countries is examined in order to draw some conclusions about the regions’ integration with international capital markets. The empirical results suggest that budget deficits in the EU member states and candidate countries have generally signaled relatively high level of substitutability between private and public savings, implying a relatively low correlation between fiscal and external imbalances. Thus, the empirical results in general reject the validity of the twin deficit hypothesis. Finally, the paper provides evidence of a relatively higher level of capital mobility, especially in the EU12+3 region in the second sub-period (2004-2008).

• Item Type: MPRA Paper
• Language: English
• Keywords: twin deficits, Feldstein-Horioka puzzle, capital mobility, EU member states, candidate countries, panel data analysis
• Subjects: F - International Economics > F1 - Trade > F15 - Economic Integration; F - International Economics > F3 - International Finance > F32 - Current Account Adjustment ; Short-Term Capital Movements; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C33 - Panel Data Models ; Spatio-temporal Models; O - Economic Development, Innovation, Technological Change, and Growth > O5 - Economywide Country Studies > O52 - Europe

References

Abel, A. B.; Bernanke, B. S. 2001. Macroeconomics. Fourth Edition. Boston: Addison Wesley Longman, Inc. 640 p. ISBN-13: 978-0201441338.

Afonso, A. 2006. Sustainability of Fiscal Policy in EU-15. Research Report, CESifo DICE Report.

Afonso, A.; Rault, C. 2007. What do we really know about fiscal sustainbility in the EU. A Panel data diagnostic. European Central Bank, Working paper series no. 820, Frankfurt am Main.

Afonso, A.; Rault, C. 2008. Budgetary and External Imbalances Relationship. A Panel Data Diagnostic. European Central Bank, Working Paper Series No. 961., Frankfurt am Main.

Alexander, S. 1952. Effects of a Devaluation on a Trade Balance. IMF Staff Papers, Washington.

Aristovnik, A. 2007. How sustainable are external imbalances in selected transition countries?, Ekonomický Časopis 55(1): 19-37.

Aristovnik, A.; Berčič, B. 2007. Fiscal Sustainability in Selected Transition Countires, Ekonomický Časopis 55(7): 661-677.

Bachman, D. D. 1992. Why is the US current account deficit so large? Evidence from vector autoregressions, Southern Economic Journal 59(2): 232-240.

Barro, R. J. 1989. The Ricardian Approach to Budget Deficit, Journal of Economic Perspectives 3(2): 37-52.

Beck, N.; Katz, J. N., 1996. Nuisance vs. substance: specifying and estimating time-series-cross models, Political Analysis 6(1): 1-36.

Blanchard, O. 2006. Adjustment with the Euro: The Difficult Case of Portugal. MIT Department of Economics, Working paper No. 06-04. Cambridge.

Blanchard, O.; Gaivazzi, F. 2002. Current Account Deficits in the Euro Area. The End of the Feldstein Horioka Puzzle? Massachusetts Institute of Technology, Department of Economics, Working paper 03-05, Cambridge.

Bussiere, M.; Fratzscher, M.; Müller, J. G. 2004. Current account dynamics in the OECD and EU acceding countries – an intertemporal approach. European Central Bank, Working paper Series No. 311, Frankfurt am Main.

Corden, W. M. 1994. Economic Policy, Exchange Rates and the International System. Oxford: Clarendon Press. 331 p. ISBN: 9780226115917.

Cuaresma Crespo, J.; Reitschuler G. 2007. Is the Ricardian Equivalence Proposition an »Aerie Fairy« Theory for Eruope? Economica 74(296): 682-694.

Darrat, A. F. 1988. Have large budget deficits caused rising trade deficits?, Southern Economic Journal 54(4): 879-887.

Dumludag, D. 2009. An analysis of the determinants of foreign direct investment in Turkey: the role of the institutional context, Journal of Business Economics and Management 10(1): 15-30.

Evans, P. 1988. Do budget deficits affect the current account? Unpublished paper, Ohio State University.

Feldstein, M.; Horioka, C. 1980. Domestic Saving and International Flows. Economic Journal 90(358): 314-329.

Fidrmuc, J. 2003. The Feldstein-Horioka Puzzle and Twin Deficits in Selected Economies, Economics of Planning 36(2): 135-152.

Franco D.; Balassone F.; Francese M. 2003. The Debate on European Fiscal Rules. Focus on Transition 1/2003.

Greene, W. H. 2002. Econometric Analysis. Fifth Edition, New York: Prentice Hall. 1026 p. ISBN-13: 978-0130661890

Hauner, D.; Kumar, M. S. 2006. Fiscal Policy and Interest Rates: How Sustainable Is The »New Economy«? IMF Working paper, WP/06/112.

Herrmann, S.; Jochem, A. 2005. Determinants of current account developments in the central and east European EU member states – consequences of the enlargment of the euro area. Discusion Paper Series , Economic Studies No. 32, Frankfurt am Main.

Hsiao, C. 2006. Panel Data Analysis: advantages and challenges. University of Southern California, Institute of Economic Policy Research, IEPR Working Paper 06.49.

Hutchison, M. M.; Singh, N. 1993. Long-term international capital mobility: new evidence from equilibrium real interest rate linkages. Federal Reserve Bank of San Francisco, Pacific Basin Working Paper Series, No. 93-06.

Islam, M. 1998. Brazil’s Twin Deficits: An Empirical Examination, Atlantic Economic Journal 26(2): 121-129.

Kandogan, Y. 2004. Trade creation and diversion effects of Europe’s regional liberalization agreements. University of Michigan-Flint, Working paper No. 07.

Kearney, C.; Monadjemi, M. 1990. Fiscal Policy and Current Account Performance: International Evidence on the Twin Deficits, Journal of Macroeconomics 12(2): 197-219.

Kulkarni, K. G.; Erickson, E. L. 2001. Twin Deficit Revisited: Evidence from India, Pakistan and Mexico, Journal of Applied Business Research 17(2): 97-100.

Levy, D. 2003. Is the Feldstein-Horioka puzzle really a puzzle?, in G. Agiomirgianakis; T. Biswas; J. Coakley; C. Tsoukis ed. Advances in International Economics and Finance, Kluwer Academic Publishers, pp. 49-66.

Marinheiro, C. F. 2008. Ricardian Equivalence, Twin Deficits, and the Feldstein-Horikoa puzzle in Egypt, Journal of Policy Modeling 30(6): 1041-1056.

Milesi-Ferretti, G., M.; Razin A. 1996. Sustainability of Persistent Current Account Deficits. NBER Working Paper, No. 5467.

Miller, N. C. 2002. Balance of Payments and Exchange Rate Theories. Cheltenham: Edward Elgar Publishing Limited. 192 p. ISBN-13: 9781840649543.

Nickel, C.; Vansteenkiste, I. 2008. Fiscal policies, the current account and Ricardian equivalence. European Central Bank, Working paper series No. 935, Frankfurt am Main.

Obstfeld, M.; Rogoff, K. 1996. Foundations of International Macroeconomics, Cambridge, MA: MIT Press. 832 p. ISBN-13: 978-0262150477.

Tvaronavičius, V.; Tvaronavičiene, M. 2008. Role of fixed investments in economic growth of country: Lithuania in European context, Journal of Business Economics and Management 9(1): 57-64.

Ucal, M.; Ozcan, K.M.; Bilgin, M. H.; Mungo, J. 2010. Relationship between financial crisis and foreign direct investment in developing countries using semiparametric regression approach, Journal of Business Economics and Management 11(1): 20-33.

Vamvoukas, G. A. 1999. The Twin Deficits Phenomenon: Evidence from Greece, Applied Economics 31(9): 1093-1100.