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Structural Challenges for Europe

Edited by Gertrude Tumpel-Gugerell and Peter Mooslechner

The main thrust of the book is that the sharing of mutual experiences is important for generating an acceptable policy mix, both at EU and national levels. The contributors highlight key financial issues, including the role of FDI and of foreign banks in the still ‘under-banked’ acceding countries, the re-launch of social security systems and the fiscal challenges of financing the catch-up process. They also examine the ongoing EU debate surrounding the application of the Stability and Growth Pact in Central and Eastern European Countries (CEECs) and go on to explore the contrasting evidence that some CEECs have shown more extensive privatisation efforts than some EU countries.
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Chapter 11: Twin deficits – implications of current account and fiscal imbalances for the accession countries

Jarko Fidrmuc


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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