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Impact of government balance and exchange rate regime on current account during the economic cycle: evidence from CEE countries

Zoran Grubišiæ (), Sandra Kamenkoviæ () and Aleksandar Zdravkoviæ ()
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Zoran Grubišiæ: Belgrade Banking Academy, Zmaj Jovina 12, Belgrade
Sandra Kamenkoviæ: Institute of Economic Sciences, Zmaj Jovina 12, Belgrade
Aleksandar Zdravkoviæ: Institute of Economic Sciences, Zmaj Jovina 12, Belgrade

Zbornik radova Ekonomskog fakulteta u Rijeci/Proceedings of Rijeka Faculty of Economics, 2018, vol. 36, issue 1, 309-336

Abstract: The key goal of this research is to empirically determine whether the fiscal policy and the choice of exchange rate regime played significant role in current account determination in 16 CEE countries, with respect to large cyclical fluctuations of economic activity in the period 1999 – 2012. The methodology is based on the panel estimation of the impact of exchange rate regimes and government balance, being the key explanatory variables, on current account balance. The main results show that contrary to the “twin deficit” hypothesis government balance had nonsignificant and negative association with current account. On the other hand, fixed exchange rate regime contributed to the accumulation of current deficits, especially during the boom years. The results of the estimation are robust to the different model specifications and estimation methods applied. It is indicated that divergence between current and government balance is associated with the fluctuations of the economic activity, since the increase in government revenues during the good years reduced deficits despite pro-cyclical fiscal policy. Also, it has been argued that in the period prior to the crisis, in the countries pursuing fixed regimes current deficit was accumulated at higher pace when compared to countries with floating regimes, despite appreciation pressures deriving from the large inflow of foreign capital. Based on the results of empirical analysis, the recommendations on benefits of floating regimes are given to policy makers in CEE countries.

Keywords: twin deficit; exchange rate regime; current account; CEE; panel analysis (search for similar items in EconPapers)
JEL-codes: F32 C23 E32 E62 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:rfe:zbefri:v:36:y:2018:i:1:p:309-336