A lower budget deficit would thus reduce our trade deficit. In macroeconomics, the twin deficits hypothesis or the twin deficits phenomenon, is the. We examine contemporaneous policy documents, including budget. The paper tests the validity of the twin deficits hypothesis. Hence this article is a revisit to the existing debate to see whether fiscal deficit and current account deficit can be called as twin deficits.
November 2005 abstract appealing to the twin deficit hypothesis, according to which shocks to the government budget. The interest rate and inflation stability should, therefore, be the target variable for policy makers. Pdf twin deficit hypothesis has become a popular phenomenon beginning from 1980s when usa has experienced huge budget and. Contrary to the assertion of the twin deficits hypothesis, the results of this research reveal a significant negative longrun relationship between fiscal and current account deficits.
Similarly azgun 2012 also found evidence for the twin deficit hypothesis in context of turkish economy for the post adoption of economic reforms in the period 19802009. Secondly, the author proposes that causality runs from trade deficits to fiscal deficits when the free tradebalanced trade theory is overthrown, and finally, the article overturns the argument that austerity works. The twin deficit hypothesis proposes that higher fiscal deficits lead to higher current account deficits. In the earlier episode, there were significant tax rate cuts that were not matched by spending cuts, and between 1981 and. The purpose of this study is to test the hypothesis of twin deficits for period. Pdf testing for twin deficits and ricardian equivalence. Which among twin deficits hypothesis, twin divergence, and. The twin deficits hypothesis in developing countries. Oct 18, 2020 a twin deficit otherwise known as double deficit occurs when a nation has both a current account deficit and a fiscal deficit tonia, 2007. Current account and budget deficits the national income identity yt. It then applies different econometric techniques to test the validity of these theories. Instead, the evidence points strongly to reverse causality, that is, the current account causes the fiscal account. We make use of annual macroeconomic data spanning from 1990 2017.
In order to fulfil the objectives, the paper starts with a descriptive. Testing the twin deficit hypothesis for kenya 19702012. To some analysts, this situation seems very reminiscent of the early 1980s. The effect of fiscal consolidation on the current account by john bluedorn and daniel leigh this paper investigates the effect of fiscal consolidation on the current account. Pdf revisiting the twin deficit hypothesis for the economies of. Twindeficits dynamic effects of balancing the budget. Testing the validity of the triplet deficit hypothesis for. To sum up, under the conventional view, direct and indirect links between the two deficits are demonstrated. Purpose this paper investigates the twin deficit hypothesis for ghana in view of the persistent comovement between the budget deficit bd and current account deficit cad over the past three decades. Twin deficit relationship in a developing open economy.
If the twin deficit hypothesis is true, policymakers can control. If the budget is in deficit then the government is a net borrower. In twin deficit hypothesis, the savingsinvestment balance in economics overall balance is ignored karanfil and k. Triple deficits theory is based on the mutual interaction between three deficit with the inclusion of domestic savings deficit in addition to the current account and budget deficits called as twin deficits with. According to this hypothesis, a tax cut lowers national saving by increasing private disposable income and hence private consumption an increase in imports causing a worsening of the cad. The e ect of fiscal consolidation on the current account john c. The paper first discusses the theoretical foundations of the twin deficit hypothesis and the main competing theories.
The results lend support to the twin divergence hypothesis and indicate that an increase in fiscal deficit improves the current account deficit. The paper is thought to be significant because the concept of the twin deficit hypothesis is fraught with controversy. The twin deficits hypothesis asserts that a reduction in the budget deficit causes a reduction in the trade deficit. However, there is no identical perception on the relationship between fiscal deficit and current account deficit both theoretically and empirically. The twin deficit hypothesis in egypt sciencedirect. More elaborate explanations in support of the twin deficits hypothesis draw upon the quantitative. This paper examines the validity of the twin deficits hypothesis in nine members of the organizations for economic cooperation. The twin deficits hypothesis says that the current account deficit and the fiscal deficit move together, at least in long run. Recent twin deficit experience of ukraine is described.
Squaring theory, evidence and common sense1 giancarlo corsetti european university institute, university of rome iii and cepr and gernot j. The twin deficit and the macroeconomic variables in kenya. Hence this article is a revisit to the existing debate to see whether fiscal deficit and current account deficit can be called as twin deficits pertaining mainly to indian economy. In 1 5, ta denotes the taxes, tr denotes the transfer expenditures, i denotes the. Furthermore, the data used for hypothesis was obtained from 2004q12017q4. This study reexamines the long run relationship between the budget and current account deficits in an oildependent open economy like nigeria using a multivariate granger causality test within the vecm framework. The twin deficits theory has intrigued economists and policymakers alike for the past few decades. If policymakers know which hypothesis is valid for the economy of a given country, they can make better decisions to deal with a. This result confirmed the existence of a long run relationship between the budget and current account deficit in nigeria, thus supporting the mudellfleming theory and refuting the. The first hypothesis, the keynesian preposition is a key ingredient of the twin deficit hypothesis. Baharumshah, ismail and lau 2009 found evidence for the twin deficits hypothesis for malaysia, thailand and philippines but there was no evidence for indonesia and singapore. Designmethodologyapproach the paper uses annual data for the period 19802014 and ascertains whether there is longrun association between the budget and current account. We examine more than the three decades of time series data to answer.
Using yearly data for the period between 1970 and 2010 in 33 european countries, we find evidence supporting the hypothesis that a chronic and robust budget deficit generates a trade deficit. Aug 20, 2019 the twin deficits hypothesis is based on the mundellfleming model fleming, 1962. Assessing the twin deficits hypothesis in selected oecd. Thus, the empirical results in general reject the validity of the twin deficit hypothesis. Moreover, given the emphasis on free trade, decentralization and growth, there is a need to. The studies examining twin deficit hypothesis which indicates that a rise in budget deficits leads to current account deficits, conclude with different results. The twin deficits hypothesis states that a budget deficit will lead to a current account deficit.
The empirical results show a positive finding of the twin deficits model derived from the incomeexpenditure equilibrium. This paper analyses the twin deficits hypothesis in india covering the period april, 199495 to july, 2014. Twin deficits hypothesis asserts that an increase in budget deficit will cause a similar increase in current account deficit. Testing for twin deficits and ricardian equivalence hypotheses. Standard macroeconomic theory points to how a budget deficit can be a contributing factor to a current. Analysis of twin deficits hypothesis in indonesia and its impact on. Third, the test of the twin deficit hypothesis results in conclusions not robust to the time horizon changing from the short to the long term. Jayaraman and chee keong choong and siong hook law, 2010 testing the validity of twin deficit. Although there are so many studies in the literature on twin deficit hypothesis, there.
However, unlike previous empirical evidence on this subject, for a year, the. The empirical literature relevant to twin deficit hypothesis may be classified into four separate groups according to the results obtained. The principal goal of this paper is to test the twin deficit hypothesis on a sample of bulgarian data from 20002010. Bb calculates trade deficit data on free on board fob m.
Citeseerx document details isaac councill, lee giles, pradeep teregowda. Fourth, even in the context of a government committed to and successful in balancing its budget in the 90s. The dynamic estimates show that a 1 % decrease in the government budget. The paper tests the validity of the twin deficits hypothesis, using annual time series data for the 19662015. A multivariate var model integrating the real effective exchange rate was used, departing from the various bivariate analyses conducted in testing the twin deficit hypothesis. The paper tests the validity of the twin deficits hypothesis, using annual time series data for the 19662015 period. Additionally, we utilise novel timeseries cointegration techniques such as the ardl bounds and granger causality analysis. Use the free adobe acrobat reader to view this pdf file.
Using quarterly data for the open economy, the outcomes reject the twin deficits hypothesis. Twin deficits, twenty years later federal reserve bank. Mundell, 1963, an expansionary fiscal policy financed by debt causes an increase in interest rates. The statistical technique advocated by toda and yamamoto 1995 for handling economic variables that might spuriously move together is utilized to examine the long run causal relationships between budget and current account deficits. In chapter 4, the macroeconomic effect of budget deficits in ukraine is discussed. The two deficits were called twin deficits because they move in the same direction amount and they derived from the same economic fundamentals. This assertion has been the subject of debate in the scholarly and policy front.
Economists qualify this as absence of free lunch which means government. Testing the validity of twin deficit hypothesis in pacific. The twin deficits hypothesis can be regarded as the determination of whether there is a causality relationship going from public sector deficit to current account deficit. According to this model an expansionary fiscal shock in an open economy, under a flexible exchange rate regime. Finally, section 5 provides the concluding remarks and the discussion of the policy implications.
The twin deficits hypothesis in developing countries international. This paper provides new evidence on the existence and magnitude of the twin deficits in developing economies. The twindeficits theory has intrigued economists and policymakers alike for the past few decades. Knowing whether the twin or triple deficit hypothesis is valid for a country is highly important for policy selection.
This question is closely related to the twin deficits hypothesis the notion that. In recent years, the twin deficits hypothesis the argument that budget deficits fuel current account deficits has returned to the forefront of the policy debate. In 15, ta denotes the taxes, tr denotes the transfer expenditures, i denotes the. The fourth section outlines the modeling strategy and the fifth section reports the results of panel data analysis. And obviously a budget surplus will improve the current account deficit. We can simply classify them as studies supporting twin deficit hypothesis and studies. The empirical results strongly suggest reverse causality, a. Mundell, 1963, which asserts that an increase in budget deficit will cause an upward shift in interest rate and. In section 4, we test the twin deficit hypothesis and present our empirical results.
The first part of the twin deficits hypothesis the causal link between the fiscal balance and. The improvement of budget deficits and current account deficits has renewed the debate over the twin deficits hypothesis. The study using modern econometric methods for estimation which showed that the twin deficits hypothesis was valid for the indian economy as the result from the cointegration test showed the existence of long run equilibrium relationship between the budget deficit and the current account deficit. Theoretical considerations of the twin deficit hypothesis are applied to investigate budget deficit and current account deficit phenomenon in ukraine. Purpose this paper investigates the twin deficit hypothesis for ghana in view of the. This paper examines the validity of the twin deficits hypothesis in nine members of the organizations for economic cooperation and development oecd over the period 19902007. According to baharumshah and zubaidi 2006, most of the developed countries, such as sweden and germany, also started to investigate the validity of the. The aim of this study is to assert empirically the effect of budget deficit on current account deficit, i. Investigation showed that budget deficit and current account deficit are cointegrated and a government budget deficit grangercauses a current account deficit.
Twin deficits in developing economies international monetary fund. Sep 30, 2020 fiscal consolidation, cad and twin deficit hypothesis explained in hindi. An empirical investigation of budget and trade deficits. According to the traditional mundellfleming model fleming, 1962.
In recent years, the turkish economy has been characterized by soaring budget deficits and deteriorating trade balances. Resorting to panel data analysis, this study finds evidence in support of the twin deficit hypothesis in terms of their short and long run relationship and suggests suitable policy measures for consideration by decision makers. Indonesia with the budget deficit which is influencing the current account deficit. Draft fiscal stability, trade policy, and implications for. This paper discusses the ongoing debates surrounding the issue of twin deficits in malaysia. And so, when the interest rate effect is integrated in the analysis, the impact of the budget deficit on the current account deficit is negative.
A natural question is whether making progress along one dimension reducing budget deficits is likely to facilitate progress in terms of limiting external imbalances. The twin deficits hypothesis was and is presented as an unquestionable accounting identity. Pdf is the comovement between budget deficit and current. Higher and persistent level of fiscal deficit and current account deficit is the problem of the day for indian economy. The twin deficit hypothesis is tested empirically by employing cointegration and grangercausality tests. Twin deficits, twenty years later federal reserve bank of. This study examines causation between the current account and the fiscal surplus and fiscal spending for a commoditybased economy, peru. Some researches support the hypothesis that there is a positive relationship between. Asset price boom and rapid dd growth, so government cut spending to reduce. The relevant literature in the research area is presented in section 3. In macroeconomics, the twin deficits hypothesis or the twin deficits phenomenon, is the observation that theoretically, there is a strong causal link between a nations government budget balance and its current account balance.
In other words, this paper provides evidence of the twin divergence hypothesis and therefore, adds to demonstrate t thatthe twin deficits the fac hypothesis shouldnot necessarily gain universal accepta over the twin divergence bility counterpart. That is, there exist a comovement between fiscal deficits and the. The idea of the fiscal balance to have a statistically significant impact on the current account is known as the twin deficits hypothesis, which this study seeks to investigate. Twin deficits hypothesis tdh that explains the existence of. If the government deficit results from high government spending g1g 2, then will imply a ca deficit. In a keynesian economy, budget deficit increases the. Otherwise, if the budget deficit improves trade deficit, it is called twin divergence hypothesis, and ricardian equivalence occurs when an increase in budget deficit has no effect on trade deficit azgun, 2012. The first model that analyses the link between budget deficit and current account deficit is the mundell fleming model, which supports the twin deficits hypothesis.
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