Chapter 11: Twin deficits – implications of current account and fiscal imbalances for the accession countries
11. Twin deﬁcits – implications of current account and ﬁscal imbalances for the accession countries Jarko Fidrmuc 1. INTRODUCTION1 Growing ﬁscal and current account imbalances in a relatively large number of countries have motivated increasing research on so-called twin deﬁcits. Taylor (2002) discusses the development of current account deﬁcits over a period of about 120 years. He shows that external imbalances have been an important feature of the world economy, although their role has changed several times. Similarly, Kao and McCoskey (1999) look for panel cointegration in the OECD countries. Several authors address twin deﬁcits from the point of view of macroeconomic stability (see Edwards, 2001). In this vein, Halpern (1998) and Megarbane (2002) underline the negative implications of a combination of adverse factors (for instance the twin deﬁcits, high interest rates and exchange rate depreciation), which may increase the vulnerability of transition countries. Megarbane (2002) also points out a possible interrelationship between the mentioned variables: an adverse ﬁscal development has to be counteracted by a more prudent monetary policy, implying higher interest rates. He concludes that ﬁscal instruments are crucial for sound macroeconomic policy in transition countries. Therefore, twin deﬁcits should be avoided. Finally, Milesi-Ferretti and Razin (1998a and 1998b) discuss the relation between current account deﬁcits and currency crises in emerging markets. They also stress the importance of further research regarding the role of macroeconomic policies during periods of high current account deﬁcits and their reversals. In line with Kao and...
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