Current Account Targeting Hypothesis versus Twin Deficit Hypothesis: the EMU experience of Portugal

Antonio Afonso and José Coelho

No 2021/0182, Working Papers REM from ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa

Abstract: We study the relationship between the government budget balance and the current account balance for Portugal, using quarterly data from 1999 to 2019. On the one hand, the causality tests find a unidirectional relation running from the current account balance to the government budget balance. On the other hand, IV estimations show a bi-directional relationship between these variables, and the existence of a bilateral relationship between the structural components of both balances. Even so, the policy implication is that the use of fiscal policy to correct the external imbalance, especially in an economic crisis, is not substantial, due to the small size of the estimated impact. In addition, with an ARDL model, we find a negative long run relationship between the share of public consumption on GDP and the current account balance. As expected, the variation of real public consumption produces an adverse accumulated response on the current account balance. Finally, the investment rate negatively affects the cyclical component of the current account balance and contributes to the structural improvement of the budget balance.

Keywords: budget balance; external balance; current account targeting hypothesis; twin deficits; government consumption; ARDL; causality; VAR; Portugal (search for similar items in EconPapers)
JEL-codes: C22 F32 F41 H62 (search for similar items in EconPapers)
Date: 2021-06
New Economics Papers: this item is included in nep-acc, nep-eec, nep-mac and nep-opm
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Working Paper: Current Account Targeting Hypothesis versus Twin Deficit Hypothesis: The EMU Experience of Portugal (2021)
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