Threshold effects in interactions between government budget imbalances, current account imbalances and business cycle synchronization

Abstract

The paper focuses on interactions between fiscal dynamics and current account imbalances, and their impact on business cycle synchronization in the euro area over the years 2001-2017. To join these two effects, we used panel data threshold model, which determined three intervals of current account differences and estimated separate relation between fiscal disparities and output gap disparities in each interval. If current account differences are small (1st interval), the threshold model concluded for strong positive effect of smaller budget balance differences on business cycle synchronization. Nevertheless, higher current account differences (2nd and 3rd interval) are accompanied by not significant or negative effect of budget balance differences on output gap differences, i.e. there is no effect of fiscal convergence on business cycle synchronization. As far as policy implications, if economic policies try to achieve tighter business cycles by a fiscal convergence, they need to take into account possible tools how to decrease current account imbalances as well.