Current account imbalances and the success of fiscal consolidations in europe

For EU countries, reducing debt levels and restoring external competitiveness are at the core of economic policies aiming to improve their future growth performance. The link between domestic fiscal policy and the determinants of external competitiveness (mainly the real exchange rate) is especially interesting, since fiscal policy is the main macroeconomic policy tool retained in national for members of Eurozone. Existing empirical studies suggest that government consumption is an important driver of medium-term real exchange rate movements for a high number of countries (Ricci et al., 2008; Lee et al., 2008; Lane and Milesi-Ferretti, 2004; Galstyan 2007). Froot and Rogoff (1991), De Gregorio et al.  Chinn (1999) also found that increases in government consumption are associated with long-run real appreciation. At this stage, to analyze the effects of fiscal adjustments on external balances becomes more insightfull. It is commonly accepted that current accounts improve in countries with contractionary fiscal policies, whereas current accounts deteriorate in countries with expansionary policies, but the channels through which fiscal adjustments affect the current accounts such as saving and investment,relative prices, and the exhange rate régime have to be analyzed. The aim of this paper is to investigate the effects of fiscal consolidations on the current accounts in the euro area over the period 1991-2008. I split the overall period into two subperiods: 1991-1998 and 1999-2008. For the empirical analysis, I use data from the AMECO database of the European Commission. The accent will be put on a comparison between a group of "northern countries" (Germany-the Netherlands-Austria) with large current account surpluses and a group of "southern countries" (Portugal, Spain, Greece) with large current account deficits. Preliminary results suggest that the current account surplus in north is a result of fiscal consolidation and the current account deficit in south is due to the investment-saving gap in private sector.

Key words: fiscal consolidation, external imbalances, Euro area.

JEL codes: E62, F41, F15, F32.