Twin deficits and the Feldstein-Horioka puzzle: a comparison of the EU member states and candidate countries

Abstract

The paper’s main objective is to investigate the empirical link between the fiscal balance and the current account (i.e. the twin deficits phenomenon). The paper focuses on the EU member states and candidate countries which are according to their different (e.g. historical, political, economical and geographical) characteristics divided into two major groups, i.e. old EU member states (EU15) and new EU member states and candidate countries (EU12+3) in the 1995-2008 period. Additionally, the importance of the so-called Feldstein-Horioka puzzle in the considered countries is examined in order to draw some conclusions about the regions’ integration with international capital markets. The empirical results suggest that budget deficits in the EU member states and candidate countries have generally signaled relatively high level of substitutability between private and public savings, implying a relatively low correlation between fiscal and external imbalances. Thus, the empirical results in general reject the validity of the twin deficit hypothesis. Finally, the paper provides evidence of a relatively higher level of capital mobility, especially in the EU12+3 region in the second sub-period (2004-2008).twin deficits, Feldstein-Horioka puzzle, capital mobility, EU member states, candidate countries, panel data analysis