Optimal Fiscal Policy Mix and Current Account Imbalances: the case of Greek Economy
Panagiotis Chronis, George Palaiodimos

The paper investigates the twin-deficit hypothesis for Greece within a small-scale VECM with a non-trivial fiscal side over the period 2000q1-2011q4. Our approach enables us: firstlyto formulate and explicitly put into hypothesis testing regarding the role of alternative fiscal policy instruments on the trajectory of the current account and secondly to evaluate the effectiveness of the current austerity mix in macroeconomic imbalances. Allowing for a number of factors that influence the long run equilibrium of the current account adjustment we find no evidence against the twin-deficit hypothesis.Still the fiscal deficit pass through into current account imbalances is moderate. Additionally, even though government expenditure reductions are consistent with an improvement in current account position, total taxation increases appear to deteriorate external imbalances despite the positive contribution they have in fiscal deficit reduction. Effectively, this is attributed to the effect that taxation hikes have on price competitiveness. Lastly, when disaggregating the fiscal deficit to its components we find evidence that indirect taxation increases have adverse results compared to direct taxation increases when it comes to reducing existing current account imbalances. At the expenditure side, wages moderation and public investment increases reduce current account imbalances indicating, in the latter case, the existence of significant productivity and competitiveness externalities for the Greek economy.

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