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Ricardian equivalence and twin deficits hypotheses in the euro area

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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.

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Notes

  1. For an exhaustive survey on the literature concerning the macroeconomic effects of government debt, see Elmendorf and Mankiw (1998). Moreover, Seater (1993); Ghatak and Ghatak (1996), and Ricciuti (2003) present rich surveys on the impact of budget deficits on trade deficits.

  2. See the website: http://data.worldbank.org/topic.

  3. See the website: http://ec.europa.eu/economy_finance/ameco/user/serie/.

  4. The big countries group includes France, Germany, Italy and Spain. The small countries group concerns Austria, Belgium, Cyprus, Estonia, Finland, Greece, Ireland, Luxembourg, Malta, The Netherlands, Portugal, Slovakia and Slovenia.

  5. It is an acronym for Barro, Armey, Rahn, and Scully, the major contributors to the development of this theory.

  6. Index of Globalization (1970-2010 mean): high globalization group: the Netherlands 83.07; Luxembourg 82.91; Belgium 82.67; Ireland 81.64; Germany 76.13; Austria 75.92; Estonia 72.62; France 70.97; Finland 70.43. Low globalization group: Slovakia 70.33; Slovenia 67.82; Spain 65.57; Portugal 63.05; Italy 62.91; Malta 62.20; Cyprus 59.89; Greece 58.38. See the website: http://www.qog.pol.gu.se.

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Authors and Affiliations

  1. Sapienza, University of Rome, Rome, Italy

    Francesco Forte

  2. Italian Society of Public Economics, Pavia, Italy

    Francesco Forte

  3. Roma Tre University, Rome, Italy

    Cosimo Magazzino

  4. Italian Economic Association, Ancona, Italy

    Cosimo Magazzino

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  1. Francesco Forte
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  2. Cosimo Magazzino
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Forte, F., Magazzino, C. Ricardian equivalence and twin deficits hypotheses in the euro area. J. Soc. Econ. Dev. 17, 148–166 (2015). https://doi.org/10.1007/s40847-015-0013-4

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