The Macroeconomic Effects of Budget Deficits in Greece: A VAR-VECM Approach

Abstract

This paper investigates the causal links between budget deficit (BD) and other macroeconomic variables such as Consumer Price Index (CPI), Gross Domestic Product (GDP) and Nominal Effective Exchange Rate (NEER) for Greece, during the period 1980-2009. Empirical evidence based on Variance Error Correction Model (VECM) and variance decomposition estimates indicate that the variables under study are cointegrated and that one-way causalities exist running from NEER to BD and from BD to GDP. Moreover, results imply that bidirectional causal links between NEER and CPI exist in the case of Greece while GDP granger-causes CPI. However, this study finds no significant links between budget deficit and inflation in the case of Greece. Therefore, this paper highlights the fact that NEER has a direct impact on Greece’s budget deficit, which is in line with the majority of relevant academic works. So, the Greek government should closely monitor the impact of NEER on the budget deficit of Greece, especially under the severe macroeconomic pressure that the sovereign debt crisis causes on the Greek economy since 2009.

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