The Relationship Between Current Account and Budget Deficits: Evidence from the Eurozone

This chapter aims to provide a thorough exposition of the twin-deficit hypothesis and present existing evidence from the eurozone south periphery. A case study focusing on a small group of highly indebted economies of the eurozone south periphery (i.e. Greece, Spain and Portugal) sheds light on the statistical association between government and current account balances and investigates the extent to which investment is highly associated with external deficits in this group of countries. New empirical evidence suggests that fiscal austerity currently employed in the eurozone periphery could be a plausible remedy for current account imbalances (under specific conditions) and that investment has heavily deteriorated the current account in Greece, Portugal and Spain, indicating that the way that investment is financed should be of primary policy consideration.