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Ricardian equivalence and twin deficits hypotheses in the euro area

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  • Francesco Forte
  • Cosimo Magazzino

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Abstract

This paper analyzes two fundamental hypotheses of fiscal policy literature: the well-known Keynesian Twin Deficits and the Ricardian Equivalence. Using yearly data for the 1970–2010 years, we studied the Euro Area countries. A key requirement of sustained economic growth states that the current account deficit and the budget deficit should be under control. During the last decades a major controversy has emerged on the sign of fiscal multiplier, that is, positive (Keynesian or conventional view), zero (Ricardian view), or negative (expectational view). The empirical findings of our study show mixed results. In fact, for the static panel data, fixed effects and random effects estimates are in line with the Ricardian approach; while Pooled OLS and Prais–Winsten (GLS) reach the opposite conclusion, since the government budget/GDP ratio coefficient is positive and statistically significant (somewhere in the range of 0.14–0.18 %). Moreover, the estimates of two sub-groups constructed with the Index of Globalization confirm the Ricardian hypothesis. In regard to the dynamic panel data, the Anderson–Hsiao IV estimators indicate that only the first lag of government budget has a positive and significant effect on trade deficit, while the more reliable GMM methods seem to be consistent with the Ricardian view. The Common Correlated Effects Mean Group estimates show that RE holds for 1970–1991 years, while in the second sub-period results are in line with the Keynesian view. Finally, FMM estimates produce three homogeneous groups, confirming previous results. Yet, mixture models provide empirical support to TD hypothesis, with effects differentiated among clusters. Copyright Institute for Social and Economic Change 2015

Suggested Citation

  • Francesco Forte & Cosimo Magazzino, 2015. "Ricardian equivalence and twin deficits hypotheses in the euro area," Journal of Social and Economic Development, Springer;Institute for Social and Economic Change, vol. 17(2), pages 148-166, October.
  • Handle: RePEc:spr:jsecdv:v:17:y:2015:i:2:p:148-166
    DOI: 10.1007/s40847-015-0013-4
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    More about this item

    Keywords

    Fiscal policy; Ricardian equivalence; Twin deficits; Causality; Euro area; Panel data; E62; F32; F41; H62;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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