THE IMPACT OF PUBLIC DEBT ON THE TWIN IMBALANCES IN EUROPE: A THRESHOLD MODEL
THE IMPACT OF PUBLIC DEBT ON THE TWIN IMBALANCES IN EUROPE: A THRESHOLD MODEL

Summary/Abstract: Recent empirical research rejecting twin deficits in indebted countries and current account imbalances adjustment in Europe led to the idea to test the twin imbalances at different public debt-to-GDP intervals. The analysis covers 14 EU countries over the time period 1995-2012. A panel data threshold model with fixed effects estimates two debt-to-GDP thresholds (40.2% and 96.6%), which determine three debt-to-GDP intervals in the twin relationship. If public debt-to-GDP is less than 40.2%, the model determines a negative relationship (twin divergence) between budget balance and current account. Twin deficits (surpluses) are confirmed exclusively if debt-to-GDP is in the interval between 40.2% and 96.6%. A twin divergence is also confirmed if public debt-to-GDP is more than 96.6% (e.g., as in Greece and Italy). The results confirm that increased indebtedness in European countries contributed to their current account imbalance adjustment.

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