Current account deficits and sustainability: Evidence from the OECD countries

Whether or not a current account deficit sustainable has important implications for policy. If the current account deficits of a nation is sustainable, then it implies that the government should have no incentive to default on its international debt. In this article we examine whether or not the current account deficits for the OECD countries can be characterized by a unit root process with regime switching. The econometric methodology allows us to distinguish periods that are associated with unsustainable outcomes from those in which the intertemporal national long-run budget constraint (LRBC) holds. Among the main results, it is found that it is very likely that the LRBC will not hold for the Australia, the Czech Republic, Finland, Hungary, New Zealand, Portugal or Spain, thus signifying a red signal that the current account deficits observed during the period were probably not on a sustainable path.     

Long-run equilibrium between budget deficits and long-term interest rates

Recently, there has been much concern about the size of federal budget deficit and its impact on interest rates. The peace time recovery after the 1981–1982 recession was the longest in U.S. history, accompanied by the largest budget deficit to GDP ratios. The present study investigates the effects of cyclically-adjusted federal deficits on long-term interest rates for 1970:1–1991:2. Using Johansen-Juselius procedures, we find evidence of a long-run relationship between federal budget deficits and long-term interest rates.     

A Cointegrating approach to budget deficits and long-term interest rates

A cointegrating approach is undertaken in this study to determine if there is a long-run equilibrium relationship between budget deficits and long-term interest rates for the United States and nine European countries. The cointegration approach consists of conducting cointegration tests and then testing several hypothesized values for the deficit and price expectations variables. The cointegration results suggest the existence of several significant cointegrating vectors for each of the ten countries, which would seem to appeal to the view of budget deficits having a positive impact on long-term interest rates. The hypothesized values for the deficit and price expectations variables are found to be too strict since the hypotheses are rejected in every case but one.     

Budget deficits and interest rates in Germany

This study uses the basic tools of cointegration to determine whether there exists a long-term relationship between budget deficits and nominal interest rates in Germany. Maximum eigenvalue, trace, and likelihood ratio tests all affirm that there does apparently exist a long-term relationship between the budget deficit and the nominal interest rate. Accordingly, regression studies and formal causality tests have a reasonable basis for investigating whether budget deficits lead to higher interest rates in Germany.     

Sustainability of public debt,public capital formation,and endogenous growth in an overlapping generations setting

Under the golden rule of public finance for public investment with a constant budget deficit/GDP ratio, we show that for the sustainability of government budget deficits there is a threshold of the initial public debt for a given stock of public capital, and that this threshold level of public debt is increasing in the stock of public capital. If the initial public debt is greater than the threshold, the government can no longer sustain budget deficits, while if it is smaller, the government can conduct a permanent deficit policy, which eventually leads to a positive public debt/GDP ratio.     

Fiscal deficits and growth in developing countries

This paper examines the relation between fiscal deficits and growth for a panel of 45 developing countries. Based on a consistent treatment of the government budget constraint, it finds evidence of a threshold effect at a level of the deficit around 1.5% of GDP. While there appears to be a growth payoff to reducing deficits to this level, this effect disappears or reverses itself for further fiscal contraction. The magnitude of this payoff, but not its general character, necessarily depends on how changes in the deficit are financed (through changes in borrowing or seigniorage) and on how the change in the deficit is accommodated elsewhere in the budget. We also find evidence of interaction effects between deficits and debt stocks, with high debt stocks exacerbating the adverse consequences of high deficits.     

Deficit spending,money, and inflation: Some international empirical evidence

An attempt is made, in this study, to examine the monetarist propositions regarding the effects of budget deficits on money growth and inflation for ten industrialized countries. To this end, a two-equation econometric model consisting of the money supply growth and inflation equations has been specified and estimated. Based on the results, it is concluded that, in general, the government budget deficit is not a determinant of money supply growth or of inflation (directly or indirectly). The U.S. is an exception with some statistical evidence of direct and indirect effects of the budget deficit on inflation.     

EXPLOSIVE BEHAVIOR IN THE 1990s NASDAQ: WHEN DID EXUBERANCE ESCALATE ASSET VALUES?*

A recursive test procedure is suggested that provides a mechanism for testing explosive behavior, date stamping the origination and collapse of economic exuberance, and providing valid confidence intervals for explosive growth rates. The method involves the recursive implementation of a right‐side unit root test and a sup test, both of which are easy to use in practical applications, and some new limit theory for mildly explosive processes. The test procedure is shown to have discriminatory power in detecting periodically collapsing bubbles, thereby overcoming a weakness in earlier applications of unit root tests for economic bubbles. An empirical application to the Nasdaq stock price index in the 1990s provides confirmation of explosiveness and date stamps the origination of financial exuberance to mid‐1995, prior to the famous remark in December 1996 by Alan Greenspan about irrational exuberance in the financial market, thereby giving the remark empirical content.

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Budget deficits, capital flows, and long-term interest rates: Cointegration findings for the united kingdom

This study uses cointegration tools to decide whether a long-term relationship exists between budget deficits and nominal long-term interest rates in the United Kingdom, as previous regression estimates have implicitly assumed. Based on maximum eigenvalue, trace, and likelihood ratio tests, as well as two cointegrating vectors, this study finds that a long-term positive relationship exists between the nominal 20-year government bond rate and the central government budget deficit.     

FEDERAL BUDGET DEFICITS, MONEY, AND EXCHANGE RATES

The dollar's strength during the 1980s appears to many—particularly as reported in the financial press—to have been directly linked to the decade's large budget deficits and the subsequent increase in the stock of federal debt outstanding. The popular argument is that the budget deficit and the growth of federal government credit market demand caused U.S. interest rates to rise over that period, inducing large capital inflows from abroad to finance the deficit. According to the argument, the capital inflows caused the dollar to appreciate. Despite the argument's popularity, the empirical literature does not strongly support it. Evidence on the relationship between the federal deficit and the dollar is at best mixed.
This article reconsiders the effects of federal budget deficits on the exchange rate. The analysis involves estimating a vector autoregressive (VAR) model of exchange rates that includes monetary, fiscal, and price level variables. Within the VAR framework, impulse analysis traces the dynamic response of exchange rates to various budget deficit measures.
The analysis finds that deficits do not directly Granger cause exchange rates, but it also finds evidence of an indirect effect working through the money supply and price level. Moreover, the analysis reveals some evidence that foreign exchange markets are forward looking and react to expected budget deficits. The innovations accounting and impulse analysis also suggest a forward-looking dynamic relationship between deficits and exchange rates, but the relationship is sensitive to the ordering of the variables.     

War and peace: Explosive U.S. public debt, 1791-2009

We show, in this study, that the U.S. public debt-GDP ratio was explosive in nature during the 1791-2009 sample period. The huge increase in U.S. debt during World War II is responsible for this result. Our findings differ profoundly from those generated by the standard unit root tests, which typically conclude that the U.S. public debt had a unit root.     

Digging out the PPP hypothesis: an integrated empirical coverage

We use several popular tests to test the validity of the Purchasing Power Parity (PPP) hypothesis. In particular, we analyze four classes of tests??standard univariate unit root tests, co-integration, panel unit root tests, and unit root tests for nonlinear frameworks??for a dataset consisting of 20 bilateral exchange rates. Through this approach, we ascertain the effectiveness of each methodology in assessing the validity of PPP. Overall, our results suggest little evidence to support PPP. Among the conducted tests, the Panel Analysis of Nonstationarity in the Idiosyncratic and Common components (PANIC) provides the richest insights by disentangling the possible sources of non-stationarity of real exchange rates. The relevance of using price indices with different characteristics is also pinpointed.     

Have the Implications of Twin Deficits Changed?: Sudden Stops over Decades

Over the last three decades, many developing countries have experienced severe currency crises. This paper presents a study of how the importance of twin deficits (budget and current account deficits) has changed in predicting sudden stops from the 1970s to the mid-2000s using data from 42 developing countries. Results show that the explanatory power of twin deficits has declined over the decades but that deficits of these kinds remain important factors for predicting sudden stops. Our results imply that a large current account deficit is an issue even when it is not accompanied by a budget deficit. This finding contradicts Lawson’s Doctrine.     

Twin Deficits in the European Countries

Public debt is a burden on future electors and taxpayers. In the absence of constitutional constraints, the incumbent government may show the cost of some public expenditures or tax reductions toward the future by financing them via new debt. However, according to the Ricardian theorem of public debt, the burden of debt is always anticipated via increased saving. If this theorem were true, a budget deficit would not affect the current account of the balance of payment. This paper analyzes the relationship between trade deficit and budget deficit. Using yearly data for the period between 1970 and 2010 in 33 European countries, we find evidence supporting the hypothesis that a chronic and robust budget deficit generates a trade deficit. The dynamic estimates show that a 1 % decrease in the government budget surplus/GDP ratio tends to deteriorate the current account/GDP ratio of 0.37 %, confirming previous studies with a different empirical basis. Dividing the sample period into two sub-periods (1970–1991 and 1992–2010), empirical findings show that current and past values of government budget influence trade balance in the first sub-period, whilst past values of government budget affect trade balance in the most recent years. Moreover, the estimated effect of government budget on current account balance is positive and equal to 0.48 and 0.30, respectively. For the high deficit countries, a long-run relationship between these variables has been found, showing that one percentage point increase in budget surplus/GDP ratio is associated with an improvement in the current account balance of roughly 0.15 percentage point. The estimated long-run government budget elasticity is negative and statistically significant, while the estimated speed of adjustment is equal to 0.33. Finally, Granger causality tests show mixed results.     

Can the Stability and Growth Pact in EMU Cause Budget Deficit Cycles?

We study whether the Stability and Growth Pact (SGP) in EuropeanMonetary Union (EMU) can induce budget deficit cycles. The SGP provides a framework forsanctioning EMU-memberswith excessive deficits. If a government's optimal deficitpolicy is above the deficit threshold which triggers penalties then the deficit will be higherwith the SGP in force than without. The SGP may even induce deficit cycles in the sense thata government switches its optimal deficit between the threshold provided by the SGP and aneven larger deficit.     

STRUCTURAL BREAKS AND UNIT ROOTS IN AUSTRALIAN MACROECONOMIC TIME SERIES

Abstract.  We examine the unit root properties of 16 Australian macroeconomic time series using monthly data spanning the period 1960–2004. In addition to the standard Augmented Dickey Fuller (ADF) test, we implement one- and two-break endogenous structural break ADF-type unit root tests as well as one- and two-break Lagrange multiplier (LM) unit root tests. While the ADF test provides relatively little evidence against the unit root null hypothesis, once we allow for structural breaks we are able to reject the unit root null for just under half of the variables at the 10% level or better.     

THE IMPACT OF GOVERNMENT DEFICITS ON PERSONAL AND NATIONAL SAVING RATES

This study provides fresh evidence on the responsiveness of private consumption and, by implication, saving to government deficits. It focuses on consumption and saving from 1981 to 1989, a period during which the personal saving rate was characterized as surprisingly unresponsive to high federal budget deficits. The authors attempt to determine whether this experience is consistent with previous behavior. They also test whether this experience refutes the Ricardian Equivalence Proposition (REP), under which consumers incorporate the government's intertemporal budget constraint into their own.
The analysis involves estimating two consumer expenditure functions based on two measures of current income capable not only of explaining expenditure behavior during the postwar period but also of successfully forecasting out of sample into the 1981–1989 period. Only one model is consistent with the REP, but neither model indicates that high government deficits caused the drop in the national saving rate experienced during the 1980s. Both models predict similar short-run responses to shifts in the government deficit. The responses depend crucially on the mix of tax and expenditure changes used to achieve the deficit shift. Both consumption and saving are more responsive to changes in government expenditures on goods and services than they are to changes in taxes.     

Unit roots and persistence in the nominal interest rate: a confirmatory analysis applied to the OECD

Abstract.  This paper investigates the stochastic properties of long-term and short-term nominal interest rates for the OECD over the post-war era. For that purpose, we employ univariate unit root tests as well as panel unit root and stationarity tests that explicitly allow for cross-sectional dependence. Overall, we find overwhelming evidence that the nominal interest rate contains a unit root, which may be driven by a stochastic common factor. The computation of half-lives through impulse-response functions also points to a high degree of persistence. This has important implications for the cointegration analysis of the Fisher equation, the uncovered interest parity, and the term structure.     

Long-term growth and persistence with obsolescence

Previous research has shown a strong positive correlation between short-term persistence and long-term output growth as well as between depreciation rates and long-term output growth. This evidence, therefore, contradicts the standard predictions from traditional neoclassical or AK-type growth models with exogenous depreciation. In this paper, we first confirm these findings for a larger sample of 101 countries. We then study the dynamics of growth and persistence in a model that renders a positive link between embodied technological progress, depreciation and output growth. We find that the model's predictions appear consistent with the empirical evidence on persistence, long-term growth and depreciation rates. In addition, we provide evidence of a unit root in output with a large battery of second-generation panel unit root tests. This supports the general validity of the endogenous growth model proposed.     

Deficit financing,liquidity, and the government budget constraint

This article presents a macroeconomic model in which government deficits are bond financed and the stock of bonds may affect both expected income and liquidity. If either of these effects exists, then comparative statics analysis requires the government budget to be balanced. Temporary divergences from a balanced budget and changes in the maturity structure of the government debt may be analyzed in terms of changes in the stock of bonds. It is shown that traditional fiscal and monetary policies may have a perverse effect; that to ensure effective policy, deficit financing and open market operations should be avoided; and that only policies involving a balanced budget or the financing of deficits or surpluses through changes in the stock of money should be undertaken.