The "Twin Deficits" Problem in Eurozone

Abstract

This thesis aims to determine the causality between current account deficits and budget deficits in Greece, Portugal, Italy and Spain during 1999-2015, which is the time period after the introduction of Euro. The econometric analysis begins with Granger causality tests of the relationship between current account and budget deficits. VAR modeling and innovation accounting is then used to analyze the dynamic interactions between the current account deficits, budget deficits, the real exchange rate and the real interest rate. The results suggest that there is no systematic causal relationship between current account deficits and budget deficits. The effect of real interest rates shocks on budget deficits is low and the effect of real exchange rates shocks on current account is also low.