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Twin deficits, twenty years later
Abstract
Recent declines in the U.S. current account and fiscal balances have sparked renewed debate over the twin-deficit hypothesis, which argues that a larger fiscal deficit, through its effect on national saving, leads to an expanded current account deficit. This study reviews international evidence on the hypothesis, finding some support for it. However, the link observed between fiscal and current account deficits is too weak to support the view that deficit reductions in the United States can play a major role in correcting the nation's current account imbalance with the rest of the world.
... The empirical evidence on the 'twin deficit hypothesis (TDH)' shows conflicting results. Bartolini and Lahiri (2006) argued that there is limited empirical support for TDH in the U.S. They observed that during a period of zero fiscal deficits, the U.S.' current account deficit did not improve substantially. ...
... So far, no study in the U.S. context allows for regime switching and asymmetric adjustment to test the twin deficit hypothesis. Some studies claim a weak connection between the twin deficits (Corsetti and Müller 2006;Bartolini and Lahiri 2006). This may be primarily attributed to a neglect of regime-switching or asymmetric adjustment between the two deficits. ...
... But Narayan (2005) argued that this result could be due to the low statistical power of the employed tests and the shortness of the sample. Bartolini and Lahiri (2006) argued that the U.S. federal deficit is too weakly related to the current account deficit. That means a fall in the budget deficit does not significantly reduce the current account deficit. ...
We revisit the twin deficits hypothesis (budget and trade deficits) for the United States during 1791–2019, using the system-equation ADL test for threshold cointegration proposed by Li (2017). This model can demonstrate the existence of both asymmetric adjustment and asymmetric role in the relationship between trade and budget deficits. Our empirical evidence suggests a nonlinear long-run relationship between the two variables, thus finding the presence of the twin deficits hypothesis. Further, we find time–varying cointegration between the two, and an asymmetric adjustment process. Budget deficits play a vital adjustment role at low regimes (when error-correction terms are below the threshold of 1.11), and trade deficits play an important adjustment role at higher regimes (when error-correction terms are above the threshold of 1.11).
... The empirical evidence on the 'twin deficit hypothesis (TDH)' shows conflicting results. Bartolini and Lahiri (2006) argued that there is limited empirical support for TDH in the U.S. They observed that during a period of zero fiscal deficits, the U.S.' current account deficit did not improve substantially. ...
... So far, no study in the U.S. context allows for regime switching and asymmetric adjustment to test the twin deficit hypothesis. Some studies claim a weak connection between the twin deficits (Corsetti and Müller 2006;Bartolini and Lahiri 2006). This may be primarily attributed to a neglect of regime-switching or asymmetric adjustment between the two deficits. ...
... But Narayan (2005) argued that this result could be due to the low statistical power of the employed tests and the shortness of the sample. Bartolini and Lahiri (2006) argued that the U.S. federal deficit is too weakly related to the current account deficit. That means a fall in the budget deficit does not significantly reduce the current account deficit. ...
We revisit the twin deficits hypothesis (budget and trade deficits) for the United States during 1791-2019, using the system-equation ADL test for threshold cointegration proposed by Li (2017). This model can demonstrate the existence of both asymmetric adjustment and asymmetric role in the relationship between trade and budget deficits. Our empirical evidence suggests a nonlinear long-run relationship between the two variables, thus finding the presence of the twin deficits hypothesis. Further, we find time-varying cointegration between the two, and an asymmetric adjustment process. Budget deficits play a vital adjustment role at low regimes (when error-correction terms are below the threshold of 1.11), and trade deficits play an important adjustment role at higher regimes (when error-correction terms are above the threshold of 1.11).
... A few other papers, such as Adam et al. (2011) andFerrero (2015), provide a more structural explanation by emphasizing the role that housing booms have played in driving current account balances, through the relaxation of collateral constraints that may also trigger a credit boom. The relationship between fiscal policy and the current account has also been widely covered in the "twin deficits" literature (see the surveys by Cavallo, 2005 andBartolini andLahiri, 2006, and the references therein). ...
... A few other papers, such as Adam et al. (2011) andFerrero (2015), provide a more structural explanation by emphasizing the role that housing booms have played in driving current account balances, through the relaxation of collateral constraints that may also trigger a credit boom. The relationship between fiscal policy and the current account has also been widely covered in the "twin deficits" literature (see the surveys by Cavallo, 2005 andBartolini andLahiri, 2006, and the references therein). ...
... Credit expansions (contractions) are typically associated with increasing (decreasing) current account deficits, and this relationship is robust to alternatives ways of filtering the credit data to extract its cyclical component. This section also presents updated evidence on the positive relationship between fiscal and current account balances, a relationship that has been studied previously and labelled as "twin deficits" in the literature (see Cavallo, 2005, Bartolini andLahiri, 2006, and the references therein). ...
We study the role that changes in credit and fiscal positions play in explaining current account fluctuations. Empirically, the current account declines when credit increases, and when the fiscal balance declines. We use a two-country model with financial frictions and fiscal policy to study these facts. We estimate the model using annual data for the U.S. and “a rest of the world” aggregate that includes main advanced economies. We find that about 30 percent of U.S. current account balance fluctuations are due to domestic credit shocks, while fiscal shocks explain about 14 percent. We evaluate simple macroprudential policy rules and show that they help reduce global imbalances. By taming the financial cycle, macroprudential rules that react to domestic credit conditions or to domestic house prices would have led to a smaller and less volatile U.S. current account deficit. We also show that a countercylical fiscal policy rule that stabilizes output growth reduces the level and volatility of the U.S. current account deficit.
... Panel data studies on this issue are relatively few. The TD hypothesis has been confirmed by empirical findings due to Bernheim (1987); Piersanti (2000); Chinn and Prasad (2003); Margani and Ricciuti (2004); Mohammadi (2004), and Bartolini and Lahiri (2006). While Giorgioni and Holden (2003a) and Bussière et al. (2005) show results in line with Neoclassical view. ...
... These empirical findings are in line with that of previous studies. In fact, previous evidence has put the range of such impacts from a high of 0.65 in Hooper and Mann (1987) to a middle of 0.35-0.50 in Congressional Budget Office (1989) and Mohammadi (2000) to a low of 0.30 in Bernheim (1987); Arora and Dua (1993); Mohammadi (2004) and Bartolini and Lahiri (2006), and close to zero in Enders and Lee (1990). ...
... This effect is similar to that shown in our dynamic panel data estimates (0.22, see Table 4), as well as in PCSEs estimates (0.20 for the subperiod 1992-2010, see Table 3), but also in POLS estimates (0.18, see Table 2). Moreover, such a value has been reached by Bernheim (1987), Arora and Dua (1993); Mohammadi (2004) and Bartolini and Lahiri (2006). ...
This paper analyzes two fundamental hypotheses of fiscal policy literature: the well-known Keynesian Twin Deficits and the Ricardian Equivalence. Using yearly data for the 1970–2010 years, we studied the Euro Area countries. A key requirement of sustained economic growth states that the current account deficit and the budget deficit should be under control. During the last decades a major controversy has emerged on the sign of fiscal multiplier, that is, positive (Keynesian or conventional view), zero (Ricardian view), or negative (expectational view). The empirical findings of our study show mixed results. In fact, for the static panel data, fixed effects and random effects estimates are in line with the Ricardian approach; while Pooled OLS and Prais–Winsten (GLS) reach the opposite conclusion, since the government budget/GDP ratio coefficient is positive and statistically significant (somewhere in the range of 0.14–0.18 %). Moreover, the estimates of two sub-groups constructed with the Index of Globalization confirm the Ricardian hypothesis. In regard to the dynamic panel data, the Anderson–Hsiao IV estimators indicate that only the first lag of government budget has a positive and significant effect on trade deficit, while the more reliable GMM methods seem to be consistent with the Ricardian view. The Common Correlated Effects Mean Group estimates show that RE holds for 1970–1991 years, while in the second sub-period results are in line with the Keynesian view. Finally, FMM estimates produce three homogeneous groups, confirming previous results. Yet, mixture models provide empirical support to TD hypothesis, with effects differentiated among clusters.
... Bartolini and Lahiri investigated the twin deficit hypothesis for Organization for Economic Cooperation and Development member countries (OECD). The results of their study provide supportive evidence for Keynesian propositions by using two sets of datasets for the 1972-1998 and 1992-2003 periods, as well as the fixed effect panel estimation method [8]. Salvatore finds strong support for the Keynesian proposition for the G-7 countries using data from 1973 to 2005 [59]. ...
... Therefore, based on the aforementioned premises, equation (8) can expressed in the following way: = ƒ ( , , FB, reer, ms) ...
... A larger budget deficit should, therefore, usually match with a larger current account deficit. (Bartolini & Lahiri, 2006). ...
... Compared to this, more open economies can keep their domestic investments stable through external loans. The increase in the deficit is accompanied by twin deficits (Bartolini & Lahiri, 2006). ...
The twin deficit hypothesis suggests that there is a relationship between the budget deficit and the current account deficit. The traditional Keynesian Approach emphasizes that budget deficits resulted in the current account deficit. On the other hand, the Ricardian Equivalence Approach argues that there is no relationship between budget deficits and current account deficit. In this study, the validity of the twin deficit hypothesis and Feldstein Horioka (1980) hypothesis is analyzed using both the Breaking Periods of the Westerlund-Edgerton Breaking Cointegration Test (2008) and the Dumitrescu & Hurlin (2012) Panel Causality Test. According to the cointegration and causality analyzes, it is concluded that there is a long-term relationship between budget deficits and current account deficits. This result supports the Traditional Keynesian Approach. Furthermore, it is seen that there is a two-way relationship between budget deficits and current account deficits. Long term coefficients were obtained by using the AMG test. When the panel coefficient results are considered, it is seen that the twin deficit hypothesis is valid, but the results are obtained contrary to the analysis found by Feldstein Horioka (1980). However, when the individual countries are examined, it is seen that the twin deficit hypothesis applies to some countries, and the twin divergence hypothesis applies to some other countries. Besides, it is understood that the study results do not support the Feldstein-Horioka (1980) hypothesis.
... Second, tax cuts will not affect national savings because a decrease in public savings will be offset by an increase in private savings, so the total amount of savings remains unchanged, which means a budget deficit has no effect on a current account deficit (Nargelecekenler & Giray, 2013). Simply, in order to be prepared for future tax increases, residents keep all the cash freed by a tax cut and therefore consumption, national savings and the current account remain unchanged (Bartolini & Lahiri, 2006). However, R. Barro (1989) states five basic theoretical remarks inconsistent with Ricardo's conclusions: first, people do not live forever and do not care about the taxes that will be levied after their death; second, private capital markets are imperfect; third, future taxes and another income are uncertain and insecure; fourth, not all tax revenues are lump-sum, most of them are determined by income, spending, and wealth; and fifth, this hypothesis is based on full employment. ...
... Certain studies have shown that, in the last few decades, it has been noticeable that changes in fiscal policies have a less impact on consumption and the current account in the group of industrial and fastgrowing economies. There are at least three reasons forcing consumers to be aware of setting aside most of tax revenues in anticipation of a future fiscal burden: the first factor is a financial innovation, which makes it easier for households to borrow from a future income, which reduces their need for liquid funds to finance consumption; the second factor is more favorable demoFigureic characteristics and linked to that, an extension of the working life as recorded in these countries in the past few decades; and finally, the introduction of "fiscal rules" has also contributed to the future behavior of households within the sample countries -the mentioned rules are reflected in the balanced budget and/or the limitation of the public sector's debt in many of the observed countries (Bartolini & Lahiri, 2006). ...
The concept of a twin deficit relates to a budget deficit and a current account deficit. In the literature, there is no unique answer to the question of what the causal relationship between these deficits is. In any case, the existence of these deficits indicates that the spending of a country is higher than its production and investments are greater than savings. The form of financing could be a potential problem, as well as the manner of the use of these funds. Crisis situations contribute to the increasing importance of the issue. In these situations, those countries where a budget deficit chronically appears and which do not have enough domestic savings to finance excessive government spending will be in a worse position. The Republic of Serbia belongs to the group of countries where a budget deficit is a chronic phenomenon financed by external sources; therefore, the paper will analyze the issue of a twin deficit.
... This was accentuated by financial openness. 2 An extension is the overlapping generations model where a negative variation in taxes affects consumption and net wealth decisions, and a current account deficit is achieved (Obstfeld and Rogoff: 1996) its initial level. Then, there is a positive linkage between the budget deficit and the current account deficit. ...
... is a vast literature about the TDH. Using data for OECD countries in the period 1972-2003,Bartolini and Lahiri (2006) find that the TDH holds. Similarly,Chinn and Prasad (2003), using a larger data, find a positive relationship between the current account deficit and the fiscal deficit (coefficient is less than one). ...
IMF policies regarding economic stabilization often include some aspect that liberalizes the financial sector of the associated country. This element of the stabilization package is often criticized since the effect of the fiscal deficit on the current account depends on the financial openness of the economy and persistence of the fiscal spending shocks. Corsetti and Müller (2006) argue that under these two conditions the relationship between fiscal deficit and current account deficit is positive in the short-run. After being a relatively closed economy for many years, Peru opened its economy in the early 1990s. Using quarterly data, fiscal surpluses and spending changes do not affect the current account across regimes. For Peru, difference in financial openness alone is not sufficient to generate different effects of fiscal shock on the current account in the short run.
... It has been argued that public sector wastefulness in some economies such the United States, post-2001 era have accounted for the accumulation of large global imbalances, which possibly contributed to the global financial and economic crises of 2008 to 2009 [1]. The argument first came up in the 1980s, when a significant deterioration in the USA current account balance was accompanied by a sharp rise in the federal budget deficit [2]. In recent decades, a number of countries both, developed and developing countries, have been experiencing persistent budget deficits accompanied by unstable current account scenarios. ...
Is there a causal relationship between budget deficit and current account deficit? This study attempts to explain the significance of the transmission mechanism, (the exchange rate and interest rate) in explaining the twin deficit hypothesis (i.e. budget deficit and current account deficit) in Namibia. The study employed analytical methods of unit roots, cointegration, Granger-causality, and the impulse response function for estimation. In contributing to this ongoing debate, the study used the case of Namibia over the period spanning from 1990-2014 using time series data. Budget deficit and current account deficit proved to be significant. There is a unidirectional causal relationship between budget deficit and current account deficit in Namibia which runs from current account deficit to budget deficit. However, the transmission mechanism proved to be less significant in explaining the twin deficit hypothesis in Namibia. Having found a positive relationship between current account deficit and budget deficit in Namibia, the government should consider curbing the increasing current account balance as a way of reducing its adverse effect on the budget balance. From this study, it is indicated that stabilising the current account deficit problem could assist in managing the budget deficit problem in Namibia.
... In the case of Japan, investment falls steadily due to the bubble years. It is worth noting that Japan's experience in the 1990s is often cited as evidence that changes in private saving can offset changes in fiscal policy, leaving Japan's CAD largely unaffected (mentioned in Bartolini and Lahiri 2006). Hatemi-J and Shukur (2002) also find that the TDH is supported for the period 1975-1989 for the USA through Keynesian hypothesis, but the twin deficits are positively linked via CAT in the later period (1990)(1991)(1992)(1993)(1994)(1995)(1996)(1997)(1998). ...
This paper investigates the causality relationship between budget and current account deficits for 14 Asian countries. The major findings based on bootstrap Granger causality tests in heterogenous mixed panels are: First, investments (and foreign capital inflows) have a notable impact on the current account prior to the Asian financial crisis of 1997–1998. Second, we detect direct causality between the budget and the current account imbalances before but not after the crisis. The data suggest that the current account targeting hypothesis, that is, the reverse causality, prevails after the crisis. Third, budget deficits have a significant influence on both investment and foreign capital inflows in the second period. Fourth, Asian countries are less susceptible to the influence of FDI inflows in the aftermath of the crisis. Finally, structural break turns out crucial in assessing the causal patterns of the twin deficits nexus in the Asian countries.
... One key feature of the equivalence theorem is that economic agents behave rationally; that is they are able to anticipate future increase in tax obligation perfectly well. Some studies that have adopted this framework include: Holmes (2011), Palhavani and Saleh (2009), Nickel and Vansteenkiste (2008, Marinheiro (2007), Zakaria and Ahmed (2007), Bartolini and Lahiri (2006), Corseti and Muller (2006), Hashemzadeh and Wilson (2006), Onofowora and Owoye (2006), Papadogonas and Stournaras (2006), Salvatore (2006), Alkswani (2001), Egwaikhide (1997) andBernheim (1987. ...
In terms of international comparisons of the growth benefits associated with the demographic dividend, ECOWAS countries stand out in the contemporary discussions. The region like others in the African continent has enjoyed a relatively sustained growth with per capita income rising steadily almost exceeding the global average. However, very worrisome are signs that this growth may not have resulted in sustainable inclusive development, creation of decent jobs (mostly for the young) and poverty reduction. Some obstacles which have been identified for the abysmal mismatch are low rates of female labour-force participation and entrepreneurship. Recent research suggests a connection between development of private enterprises as the main source of new jobs and female employment in poverty reduction. The paper on the one hand examined the empirical key determinants of female employment using longitudinal data of some ECOWAS countries and in another strand establishes how private sector development can drive the process of sustainable development and poverty reduction in the region. The paper also tested for the Boserup (1970) assertion on the gap consequences between male and female employment over time. One implication of the findings is that government policy among ECOWAS states must prioritize the creation of inclusive productive employment through a robust enabling environment for a well functioning and effective private sector.
... Given the little amount of studies devoted to the analysis of the nexus current account balance and public deficit for the APEC countries, new studies might concern the estimation of an empirical model that captures the essential features of both TD and RE theories, as in Mohammadi (2004); Bartolini and Lahiri (2006); Magazzino (2012) and Forte and Magazzino (2013). Table-A. ...
The paper analyses the relationship between trade balance and government budget for the APEC countries over the 1980-2013 years. Using a panel data techniques, a 2-variable VAR is estimated. Empirical findings show that for the whole APEC members as well as for the ASEAN sub-sample a bi-directional causality is discovered, while for the American sub-sample the Neo-classical view holds. Moreover, the forecast errors decompositions seem confirm this analysis. Cointegration tests reveal the existence of a long-run relationship between these two variables, with most of the coefficients close to 1, although several ASEAN countries represent exceptions. Finally, causality analyses show that ten countries exhibit the absence of any causal relationship, in line with neutrality Ricardian hypothesis.
... In recent years, the argument that budget deficit fuels current account deficit has returned to the forefront of policy debate. This situation was first experienced in the United States of America in the 1980s when a significant deterioration in the US current account balance accompanied a sharp increase in the federal budget deficit (Bartolini and Labiri, 2006). For a long time, studies on the link between budget deficit and current account deficit have been centred on the validity of two major theoretical models; the Keynesian proposition and the Ricardian Equivallence hypothesis. ...
... The impulse response reaches its peak after three quarters from impact and then steadily subsides for the next quarter. This is consistent with findings of Bartolini and Lahir (2006). It also matches the portfolio balance approach to balance of payments which stipulates that, following an increase in taxation the local unit depreciates due to a fall in spending. ...
We provide strong evidence of a positive shock to government spending on increase in employment (public and private), an appreciation of the real effective exchange rate and deterioration in the trade balance; but it has no effect on output for South Africa during the period 1994:1-2008:4. We also document that positive shocks to net taxes generate an increase in output, private employment and have no effect on public employment; it also leads to a depreciation of the real effective exchange rate and an improvement in the trade balance. An important finding in this study is that the transmission channel between government expenditures and output is not as direct as suggested in the Keynesian doctrine, but is indirectly shown by public employment’s effects on output. We conclude that classical effects are predominant in the South African economy, i.e., only improvements in the supply-side components can be linked to increases in output.
... The much suggested connection between an economy's budget balance and current account balance has ignited extensive debate both in the theoretical and empirical literature for quite some time now, albeit inconclusive (Bartolini and Lahiri, 2006). This review analyzes the propositions by the main schools of thought (Keynesian and Ricardian views) as well as the unidirectional reverse causality from the current account deficit to budget deficit and the bi-directional causality arguments. ...
This paper investigates the twin deficit hypothesis for Ghana in view of the persistent co-movement between the budget deficit (BD) and current account deficit (CAD) over the past three decades. The paper uses annual data for the period 1980-2014 and ascertains whether there is long-run association between the budget and current account deficits using the Johansen Cointegration test. The Error Correction Model (ECM) is estimated to check stability of the long-run association between the two deficits. A Granger causality test is performed to determine the direction of causality between the two variables.
The results confirm the existence of long-run equilibrium relationship between the budget and current account balances. The error correction model finds an insignificant effect of the BD on the CAD both in the short and long runs. The ECM result was however significant for both the long run and short run regarding the effect of CAD on BD even as the adjustment parameter suggests that 33 percent of the disequilibrium in budget balance in the previous period is corrected in the current period. Granger causality results find support for the reverse causality argument, thereby rejecting the twin-deficits hypothesis for Ghana.
... An extended area in trade imbalance research is the twin deficits theory that covers both government budget deficit and trade imbalance. Twin deficits exist in several countries including the U.S. (Bartolini & Lahiri, 2006;Tang, 2013), the U.K. (Corry, Valero & van Reenen, 2011), Greece (Panagiotidis, 2011), Portugal (Kosteletou, 2013), Italy (Weisenthal, 2013), Serbia (Urosěvić, Nedeljković & Zildžović, 2012), Thailand (Lau, Mansor & Puah, 2010) and others. ...
This paper investigates macroeconomic determinants of the trade imbalance in the U.S. and the U.K. It is based on a simple DSGE model under perfect capital mobility and flexible exchange rates assumptions of the Mundell-Fleming international trade model. Results suggest both lagged by one period money component and lagged by one period first-order differenced government budget deficit were destabilizers for contemporaneous first-order differenced current account deficit in both countries for 1990-2012. The effect of government budget deficit was weaker. Lagged by one period first-order differenced personal consumption expenditure became a medium level destabilizer for U.S. and an insignificant stabilizer for U.K. for the same current account deficit variable. The Judd-Gaspar test suggests that this model is robust in accuracy for both nations.
... They explained that the Feldstein Hoioka criterion keeps emphasizing the differences between small and large countries. Bartolini & Lahiri (2006) worked on the importance of the twin deficit hypothesis and its effect after 20 years. According to them, larger fiscal deficit by affecting national savings prolongs current account deficit. ...
The primary objective of this study is identifying the role of twin deficit and Feldstein-Horioka puzzle in Pakistan, Sri Lanka and India. Moreover, this study explores the relationship between current account deficit (CAD) and budget deficit (BD) in Pakistan, Sri Lanka and India from 1980 to 2011. According to the twin deficit hypothesis, "a larger budget deficit leads to an expanded current account deficit ". However, according to the Feldstein-Horioka puzzle, "there is a low correlation between national investment and national saving in the presence of accurate mobility of capital". Prior studies on twin deficit, conducted in South Asia, present the single country analysis, but this study is going to compare the twin deficit of 3 countries in South Asia. In order to achieve the objective and check that the data is either unit root or not one of 3 tests (Dickey-Fuller test, augmented Dickey-Fuller test, Dickey-Fuller generalized least square) can be applied. In addition, Granger causality tests, cointegration tests and error correction model can be used to examine the data. © Waheed Ahmed Alhindi, Norkhairul Hafiz Bajuri, Saqib Muneer, 2013.
... At the same time, the persistence of positive spreads in some segments of the financial market shows that surplus countries had an interest in lending their net savings to private sector agents in 'peripheral' countries (Rossi and Dafflon 2012). As a matter of fact, empirical evidence about the existence of 'twin deficits' shows that the correlation between fiscal deficits and trade deficits is rather weak: the coefficients lie between 0.1 and 0.3, meaning that a fiscal deficit of 1 euro is associated with a trade deficit of between 10 and 30 cents (see Chinn and Prasad 2003; Bagnai 2006; Bartolini and Lahiri 2006). Indeed, the empirical analysis carried out by Bagnai (2013) confirms that 'peripheral' countries within the euro area have recorded a huge increase in private sector deficits (that is, a reduction in net private savings), together with a reduction in public deficits and an increasing deficit of their current account (see Rossi 2013). ...
This paper points out that the roots of the euro-area crisis are to be found in the loss of monetary sovereignty and an unsustainable credit-led economic growth in a variety of ‘peripheral’ countries. It addresses the negative consequences of fiscal austerity in the euro-area crisis framework, in particular regarding the distribution of income and the economic and financial relations between ‘core’ and ‘peripheral’ countries within the euro area. The paper also argues that the deflationary effects of the conventional policy reaction to the euro-area crisis will aggravate recession over the medium-to-long run in that area, owing to their negative impact on demand in the product markets across the whole European Union, whose competitiveness will suffer under the very measures that are supposed to enhance it in the global economy.
... Notwithstanding its flawed free trade theoretical basis, the Mundell-Fleming explanation of the twin deficits relationship was given empirical support by Volcker (1984:4-9) and Abell (1990:81-96) for the USA in the late 1980s. Hutchinson and Pigott (1984:5-25), Zietz and Pemberton (1990:23-34), Bacham (1992:232-240), Erceg et al (2005:232-240) and Bartolini and Larhiri (2006) also established the same line of causation for OECD countries. Chinn and Prasad (2003:232-240) argue that the Mundell-Fleming explanation holds for both developed and developing countries. ...
The twin deficits debate that emerged in the late 1970s has regained fraction in recent times since the Eurozone crisis and the debt ceiling debates in the USA. The neoclassical economic contention is that imprudent government spending causes trade deficits: thus, public deficits and debt are the offenders responsible for the Eurozone trade imbalances, the USA's trade deficits and global imbalances generally. This article challenges the orthodoxy and uses a simple model and a Eurozone ease study to show that international differences in competitiveness (based on real unit labor costs and the complexity of exports) lead to unbalanced trade. The first section discusses free trade theory and its assumptions, along with the neoclassical explanation of the twin deficits and a brief review of empirical studies. The second section explains how competitiveness determines the trade balance, using a simple model and a Eurozone case study, and ends by reformulating the twin deficits relationship.
... Secondly, evidence on the "twin deficit" mechanism suggests that the relation between government and external deficit is rather tenuous. Panel studies such as Chinn and Prasad (2003) or Bartolini and Lahiri (2006) find very low coefficients (between 0.1 and 0.3), indicating that each euro of government deficit causes only 10 to 30 cents of current account deficit. Country specific studies like Bagnai (2006) show that in Italy, Spain and Portugal there is no long-run relation between the two deficits, while in Greece and Ireland a relation exists but weakens over time. ...
In this paper the author tries to reverse the "Anna Karenina approach" to the Eurozone peripheral crises; that is, to contest the idea that each financial crisis would be the consequence of a series of unfortunate and mostly idiosyncratic events, that would make it unpredictable and a case in its own, with no particular relation with other crisis episodes. It is argued that, contrary to current conventional wisdom, these crises "are all alike": they reproduce, in their essence, the main features of Minsky's "boom and bust" cycle in developing countries. This reversal of perspective, besides being supported by empirical evidence, may provide many further useful insights. First, it may allow to identify the common roots of the apparently different crises and possibly to define common management or exit strategies, looking at the previous historical experiences; second, the adoption of a common framework allows to gauge the effective relevance of country idiosyncratic features in the explanation of what is going on in the Eurozone. Resumen En este artículo el autor trata de refutar el llamado "enfoque de Anna Karenina" aplicado a las crisis de las economías periféricas de la Eurozona. Es decir, discute la idea de que cada crisis financiera resulte de una serie de eventos desafortunados e idiosincrásicos, que harían que cada una de ellas fuese impredecible y un caso particular en sí mismo, sin ninguna relación especial con otros episodios críticos. Se argumenta que, contrariamente a lo que indica el saber convencional actual, estas crisis "son todas iguales" en sus mecanismos esenciales: reproducen las principales características del ciclo minskiano de auge y caída observado en muchas experiencias de países en desarrollo. Esta perspectiva, además de ser consistente con la evidencia empírica, puede proporcionar varias contribuciones adicionales. En primer lugar, puede hacer posible la identificación de las raíces comunes de crisis en apariencia diferentes y, posiblemente, ayudar en la definición de formas de respuesta o estrategias de salida que tomen en cuenta las lecciones de experiencias históricas precedentes. En segundo lugar, la adopción de un marco común permite una mejor ponderación de la efectiva relevancia de las características idiosincrásicas de cada país en la explicación de lo que está sucediendo en la Eurozona.
... The Twin Deficits Debate Bartolini and Lahiri (2006) suggest the twin deficits hypothesis appeared to explain the American experience of the 1980s and the first part of the 21 st Century, but that it did not seem to capture the behaviour observed in the 1990s. This suggests that there may be an asymmetric link between the current account balance and the fiscal balance. ...
In this article we examine the performance of an extended approach to testing for threshold cointegration that relies on the threshold specification process suggested by Gonzalo and Pitarakis (2002) and the block-bootstrap threshold unit root test of Seo (2008). A topical application demonstrates its merits.
... Also for the US, Erceg et al. (2005) found that an increase in government expenditures and a decrease in labor income tax rates have small negative effects on the trade balance. 8 Bartolini and Lahiri (2006) found that the TDH holds for countries belonging to the Organization for Economic Co-operation and Development (OECD). In addition, for OECD countries, Bussière et al. (2005) found that the contemporaneous effects of fiscal deficits on current account deficits are significant and very small. ...
This study examines causation between the current account and the fiscal surplus and fiscal spending for a commodity-based economy, Peru. Using quarterly data for the open economy, the outcomes reject the twin deficits hypothesis. Instead, the evidence points strongly to reverse causality, that is, the current account causes the fiscal account. However, unlike previous empirical evidence on this subject, for a year, the reverse causality indicates a negative causation because the fiscal consumption is not smoothed when positive permanent shocks to the current account occur. In the short run, the fiscal policy has no effect on the current account, but improvements in the current account increase the probability of attaining a lower bounded fiscal deficit. This evidence is consistent with a small open commodity-based economy that is highly exposed and sensitive to external price shocks.
... A further dimension to the debate is that the relationship may also depend on factors such as the nature of the government budget deficit, the characteristics of countries under consideration, the international asset market structure, and the specifications of the model. A large number of studies confirm either in a time series, cross section, or panel setting, the budget balance-external balance nexus (see, for example, Chinn and Prasad (2003), Bartolini and Lahiri (2006), Bagnai (2006), Salvatore (2007)). ...
This study contributes to the debate concerning the nature of relationship between the budget and current account balance. Using a regime-switching framework applied to US data over a 1960-2008 study period, twin deficits or twin divergence best describes their long-run relationship. Whereas the budget and current account balance may exhibit short-run divergent behavior resulting from a positive technological shock, such shocks also increase the probability of being in a regime characterized by a long-run positive equilibrium relationship consistent with a Keynesian viewpoint of twin deficits.
... Also for the US, Erceg et al. (2005) found that an increase in government expenditures and a decrease in labor income tax rates have small negative effects on the trade balance. 8 Bartolini and Lahiri (2006) found that the TDH holds for countries belonging to the Organization for Economic Co-operation and Development (OECD). In addition, for OECD countries, Bussière et al. (2005) found that the contemporaneous effects of fiscal deficits on current account deficits are significant and very small. ...
This study examines causation between the current account and the fiscal surplus and fiscal spending for a commodity-based economy, Peru. Using quarterly data for the open economy, the outcomes reject the twin deficits hypothesis. Instead, the evidence points strongly to reverse causality, that is, the current account causes the fiscal account. However, unlike previous empirical evidence on this subject, for a year, the reverse causality indicates a negative causation because the fiscal consumption is not smoothed when positive permanent shocks to the current account occur. In the short run, the fiscal policy has no effect on the current account, but improvements in the current account increase the probability of attaining a lower bounded fiscal deficit. This evidence is consistent with a small open commodity-based economy that is highly exposed and sensitive to external price shocks.ResumenEste estudio examina la causalidad entre la cuenta corriente y el superávit fiscal y el gasto fiscal para un país primario exportador, Perú. Usando data trimestral de un periodo de apertura comercial y financiera, los resultados rechazan la hipótesis de déficits gemelos. En cambio, la evidencia revela la existencia de una causalidad invertida, es decir, que la cuenta corriente causa a la cuenta fiscal. Sin embargo, a diferencia de la evidencia encontrada previamente en la literatura, para un periodo de un año, existe un efecto negativo porque el consumo fiscal no es suavizado cuando se presentan los choques positivos permanentes de cuenta corriente. En el corto plazo, la política fiscal no afecta a la cuenta corriente, pero incrementos en cuenta corriente aumentan la probabilidad de superar el límite mínimo del déficit fiscal. Esta evidencia es consistente con una pequeña economía abierta primaria exportadora que esté altamente expuesta y es sensible a los choques de precios externos.
... The empirical evidence on this issue is rather mixed: while most macroeconomic models imply a causal nexus between the budget and the external deficit, this relation appears in most studies to be weak and subject to structural breaks (Obstfeld andRogoff 1995, Leachman andFrancis 2002). The more thoroughly investigated case is that of the United States, where the studies conclude almost unanimously that public and external deficit are tied by a coefficient of about 0.3 (Bagnai 2006, Bartolini and Lahiri 2006, Salvatore 2006. To the extent that external indebtedness is a problem, these results imply that it cannot be solved only by fiscal consolidation. ...
This paper analyses the relation between the external and government deficits in a panel of CEEC economies and, separately, in PIGS economies. We first assess by panel unit root tests whether the fiscal and external intertemporal budget constraints hold, and then examine the role of public and private expenditure in the dynamics of external indebtedness by panel regression. The results show the importance of private capital flows in the current external imbalances of European countries, with different implications for the two groups of countries considered.
... The budget deficit does not seem to have had a strong impact on the current account deficit. This is in line with recent studies, see for instance Bartolini and Labiri (2006), which find a weak relationship concerning the twin deficits hypothesis. ...
In this paper we investigate empirically, the factors that have affected the current account balance in the Greek Economy, primarily after the EMU accession. Using the Johansen Cointegration analysis and Error Correction Model (ECM) on quarterly data over the period 1995Q1 - 2006Q4 period, we test for the empirical importance of the factors that contributed to the recent widening of the Greek current account deficit. In particular, it is shown that, from a point of a long-run perspective, the deterioration of competitiveness, the ongoing process of real convergence, which has been primarily facilitated by strong credit growth reflecting the impact of financial liberalization and lower interest rates, the cyclical position of the Greek economy and to lesser extent the fiscal expansion, have all contributed to higher current account deficits. Also, significant role on the short-run dynamics of the current account has been played by two exogenous factors involving developments in oil and freight prices.
... Their empirical analysis supports the view that there is a long-run relationship between current account imbalances and budget deficits, and that the direction of causality runs from the budget deficit to the current account one. Starting from the U.S. experience, Bartolini and Lahiri (2006) found that, on average, each extra dollar of fiscal deficit is associated with a rise in private consumption (or a fall in national saving) of about 35 cents in the 1972–2003 period, compared with a rise in consumption between 40 and 50 cents in the 1972–83 period. Bernheim (1987) analyzed the relationship between changes in consumption and changes in deficits: the latter appear to stimulate the former by about $0.40, whilst the debt coefficient is positive. ...
Public debt is a burden on future electors and taxpayers. In the absence of
constitutional constraints, the incumbent government may show the cost of some
public expenditures or tax reductions toward the future by financing them via new
debt. However, according to the Ricardian theorem of public debt, the burden of debt
is always anticipated via increased saving. If this theorem were true, a budget deficit
would not affect the current account of the balance of payment. This paper analyzes
the relationship between trade deficit and budget deficit. 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. The dynamic estimates show that a 1 % decrease in the government budget
surplus/GDP ratio tends to deteriorate the current account/GDP ratio of 0.37 %,
confirming previous studies with a different empirical basis. Dividing the sample
period into two sub-periods (1970–1991 and 1992–2010), empirical findings show
that current and past values of government budget influence trade balance in the first
sub-period, whilst past values of government budget affect trade balance in the most
recent years. Moreover, the estimated effect of government budget on current account
balance is positive and equal to 0.48 and 0.30, respectively. For the high deficit
countries, a long-run relationship between these variables has been found, showing that one percentage point increase in budget surplus/GDP ratio is associated with an
improvement in the current account balance of roughly 0.15 percentage point. The
estimated long-run government budget elasticity is negative and statistically significant,
while the estimated speed of adjustment is equal to 0.33. Finally, Granger
causality tests show mixed results.
... On the contrary, the Ricardian Equivalence Hypothesis (REH hereafter) states that shifts between taxes and budget deficits do not matter for the real interest rate, the quantity of investment, or the current account balance, negating any link between the two deficits (Magazzino, 2012). Moreover, few studies have been devoted to the analysis of TDH for Italy (Bernheim, 1987; Kearney and Monadjemi, 1990; Blecker, 1992; Kouassi et al., 2004; Bartolini and Lahiri, 2006; Salvatore, 2006; Boileau and Normandin, 2008; Bagnai, 2010; Bluedorn and Leigh, 2011; Magazzino, 2012). The remainder of our article is organized as follows: in Section II the theoretical backgrounds and empirical evidences about these alternative theories are discussed. ...
Using time series techniques, this study explores the relationship between trade deficits and budget deficits in Italy in the period 1970-2010. Empirical findings show that current account balance and government budget are I(1) processes. Cointegration tests reject the presence of a long-run relationship between these variables. Finally, Granger-causality tests show a unidirectional flow from trade deficits to budget deficits, in line with Neo-classical view.
One of the most important economic problems of many developing countries is happening of the budget deficit and the current account deficit at the same time, that have adverse effects on performance of various sectors of the economy. In this study the twin deficit hypothesis in Iran was tested. For this purpose nonlinear relationship between budget deficit and current account deficit in the period of 1971-2012 was reviewed. At first, the stationary of time series variables examined. Then Johansen co-integration test was performed. There was a co-integration vector between budget deficit and current account deficit. The causality test in a frame of a vector autoregressive model showed a bi-directional causal relationship between the variables. Then the non-linearity test was performed and after confirmation of non-linearity, two regimes threshold vector autoregressive model was estimated. Also the unit root test of non-linear models (KS) was applied. The results showed that the current account deficit in the short run will be affected by budget deficit and current account deficit increase with the increasing of the budget deficit. But in the long run, these two variables are treated as independent together.
Among the challenges confronting sub Saharan Africa (SSA) are maintaining favorable fiscal and trade balances. Based on historical data from these countries, both balances have simultaneously trended in the negative region. This suggests the presence of the twin deficits in SSA. To provide an empirical explanation for this relationship, we adopted a dynamic panel model. The model was estimated using the Generalised Method of Moments (GMM) estimation technique. This technique is suitable because it takes care of the serial correlation problem that may exist as a result of including the lagged value of the dependent variable as a regressor in the model. The result shows a positive and significant impact of the budget balance on the trade balance, confirming the presence of the twin deficits in SSA. Also, the long run impact of the budget balance on trade balance was discovered to be 0.6 or 60%.Based on the empirical findings, the study recommends that a necessary condition in reversing the negative trend in the trade balance in SSA is maintaining a favourable fiscal balance. That is, to reverse the downward trend in the trade balance in SSA, measures should be put in place first to reverse the fiscal deficits. Also, it was recommended that if SSA countries are to reap positive gains from trade agreements like the European Partnership Agreement (EPA), they should make efforts to add value to products they send to the international market.
One of the important economic variables related to the foreign balance of countries is the current account balance of payments. Current account balance and budget balance are considered as important indicators of macroeconomic stability and welfare. The growing disequilibrium of the current account balance and the government budget balance lead to a macroeconomic imbalance. This paper analyzes the effects of monetary and fiscal policies on current account deficits in selected oil-exporting countries (Algeria, Colombia, Ecuador, Gabon, Iran, Mexico, Nigeria, Saudi Arabia, Kuwait, Angola, Congo, Indonesia, Malaysia, Trinidad, and Tobago) for the period 2000-2015 using a Panel Vector Autoregressive (P-VAR) model. The results indicate that monetary policy (by raising interest rates) will decrease the current account deficit. Considering that, in this research budget deficit coefficient is positive, as budget deficit increases (fiscal policy), the current account deficit decreases. In other words, the twin divergence hypothesis is approved for this group of countries, during the period under review. With increasing oil revenues, current account deficits will increase.
In this book, Eric J. Heikkila explores a truly important question that has not been adequately analyzed to date: how the rise of China alters the context in which the broad spectrum of policies in the United States should be assessed. Here, the policy domain of the U.S. government is carved into three broad spheres: economic policies: fiscal policy and deficits, trade policy, and employment and income sustainability policies: climate change, urban policy, and energy policy geopolitical policies: homeland security, defense policy, and foreign relations. For each domain, Heikkila assesses the key policy issues and tradeoffs, examining how the balance of such tradeoffs shifts due to China's rise. In doing so, he demonstrates how a rising China exerts its gravitation pull on U.S. policy, not so much through lobbying or negotiation, but through the very nature of its being. A concluding chapter presents a workable synthesis derived from these diverse perspectives. At a time of increasing tensions, it is all the more important for U.S. policy makers to focus on the many substantive policy questions that are impacted by China's rise. China from a U.S. Policy Perspective will be of key interest to scholars, practitioners, and students of policy analysis, U.S. politics, Chinese politics, and International Relations.
Twin deficits hypothesis suggests that there is a positive relationship between budget and current account deficits. The present study examines Twin Deficits Hypothesis over the period of 2005:01–20013:12 in Kyrgyzstan by using Vector Autoregressive Model technique. The results show that there are relationships between government expenditure, export and import. The causalities are from government expenditure to export and import. These results confirm the Keynesian view, which asserts the existence of twin deficits, meaning that the state budget deficit at weak real economy, in an open economy, increase imports, which is the cause of twin deficits in the economy of Kyrgyzstan. To solve the problem of twin deficits, the state must pursue an active foreign trade policy in addition to fiscal policy, as it is proven empirically the state budget deficit has a big impact on trade deficit, but not the main factor of trade deficit.
The main focus of the paper is to analyze the effects of both economic and political variables on public sector budget deficits. The econometric results show that the main determinants of budget deficits include international capital inflow, international interest rate, debt service costs, public expenditure, political instability and economic growth. The author makes the following recommendations. Firstly, international capital should be used to finance projects that contribute meaningfully to the economy. Secondly, since international interest rate is outside the control of Nigeria’s government and monetary authorities, emphasis on foreign loans should be reduced. Thirdly, government should avoid external debt where necessary. Fourthly, government should increase her spending on infrastructural development. Furthermore, government should strengthen the political institutions including the judiciary, as well as create a level playing ground for all its citizens, so as to promote political stability. Moreover, government should give more incentives and subsidies such as low corporate profit tax, improvement in power and energy generation, etc., in order to encourage producers as well as promote economic growth. Lastly, government should sustain the on-going war against corruption so that public funds are not misappropriated or embezzled by government officials.
We apply nonlinear autoregressive distributed lag (NARDL) approach to investigate the relationship between budget deficit and current account deficit in Croatia, Czech Republic, Hungary, Poland, Romania, Slovakia, and Slovenia. Our results indicate that changes in current account deficit have a significant effect on the budget deficit in Poland and Romania in the long-run and Croatia, Poland, Romania and Slovakia in the short-run. On the other hand, changes in budget deficit significantly affect the current account deficit in Czech Republic, Hungary, and Slovakia in the long-run and in Czech Republic, Hungary, Slovakia, and Romania in the short-run. Therefore, we conclude that the twin deficit hypothesis is valid for Czech Republic, Hungary and Slovakia but not for the case of Poland, Croatia, Romania and Slovenia in the long-run. Finally, we also present evidence for the existence of asymmetric effects in this context.
Günümüzde bütçe dengesi bilim adamları ve politikacılar tarafından oldukça fazla önemsenen konulardan birisi haline gelmiştir. Bu nedenle bütçe dengesinde sapma sonucunu ortaya çıkaran nedenler konusunda literatürde çok sayıda çalışma yapılmıştır. Bütçe dengesinde meydana gelen sapmaların nedenleri de pek çok çalışmaya konu olmuştur. Bu çalışmada enerji dengesinin bütçe dengesi üzerindeki etkisi araştırılmıştır. 34 OECD üyesi ülkenin 2003-2013 dönemi arasındaki yıllık verileri kullanılarak panel veri analizi ile araştırılmıştır. Çalışmanın ampirik bulguları enerji ithalinin bütçe dengesi üzerinde bozucu bir etki yarattığı sonucunu göstermektedir.
This chapter examines the effects of expansionary fiscal policy shocks on the current account. We find that the current account deteriorates in response to an expansionary fiscal policy shock which increases the budget deficit. This evidence is consistent with the twin deficits hypothesis. Loose monetary policy also leads to current account deficits. But expansionary fiscal policy shocks tend to dominate loose monetary policy shock effects at the peak deterioration of the current account. However, we fail to find evidence that fiscal innovation shocks that raise government spending today are followed by a period of below trend spending at some point in the future. Hence, we conclude that evidence in this chapter rejects the spending reversals hypothesis.
This paper examines the relationship between current account and government
budget deficits in Tanzania. The paper tests the validity of the twin deficits hypothesis,
using annual time series data for the 1966-2015 period. The paper is thought to be
significant because the concept of the twin deficit hypothesis is fraught with controversy.
Some researches support the hypothesis that there is a positive relationship between
current account deficits and fiscal deficits in the economy while others do not. In this
paper, the empirical tests fail to reject the twin deficits hypothesis, indicating that rising
budget deficits put more strain on the current account deficits in Tanzania. Specifically,
the Vector Error Correction Model results support the conventional theory of a positive
relationship between fiscal and external balances, with a relatively high speed of
adjustment toward the equilibrium position. This evidence is consistent with a small open
economy. To address the problem that may result from this kind of relationship,
appropriate policy variables for reducing budget deficits such as reduction in non-development
expenditure, enhancement of domestic revenue collection and actively fight
corruption and tax evasion should be adopted. The government should also target export
oriented firms and encourage an import substitution industry by creating favorable
business environments.
In this study, the period of 2005:01-2011:12, " Current Deficit " and " Special Consumption Tax " (SCT), whether or not the relationship between income tested. In this context, the series for both variables Phillips-Perron (PP) and Kwiatkowski-Phillips-Schmidt-Shin (KPSS) unit root tests, as a result become stationary after first differences of both series, they also concluded. In addition, in order to determine the causality between the variables and the Dolado-Lütkepohl Granger causality tests are completed. In this context, the current account deficit were detected in SCT, causality, causality from current deficit could not be identified Special Consumption Tax.
4 döneminde Türkiye'de ikiz açık hipotezinin (bütçe açığı ve cari işlemler açığı arasındaki ilişkiyi) geçerliliğini incelemektedir. Bütçe açığı ve cari işlemler açığı arasındaki kısa ve uzun dönem ilişkisini inceleyen çalışma, sınır testi yaklaşımını kullanmaktadır. Sonuçlar, uzun dönemde bütçe açığı ve cari işlemler açığı arasında bir ilişkinin olmadığını fakat kısa dönemde bu iki açık arasında kuvvetli bir pozitif ilişki bulunduğunu göstermektedir. Bütçe açığındaki %1'lik artış, kısa dönemde cari işlemler açığında %0,18'lik artış meydana getirmektedir. Bulgular, kısa dönemde ikiz açık hipotezinin geçerli olduğunu savunan Keynesyen yaklaşımı desteklerken uzun dönemde ise ikiz açık hipotezini reddeden Ricardocu denklik hipotezini desteklemektedir. Abstract This paper examines the validity of twin deficits hypothesis (the relationship between the budget deficit and the current account deficit) using the data period 1998:1-2010:4 in Turkey. The paper that examines the short-run and long-run relationship between the budget deficit and the current account deficit uses the bounds testing approach. Our results show that there is no long-run relationship between the two deficits but there is a strong positive relationship between the two * Arş. Gör.
This study examines the empirical relationship between fiscal deficit and current account imbalance in both short and long run, employing data on Nigeria for the period 1960 to 2011. We employ cointegration analysis and VAR/VEC granger non causality process. Johansen and Juselius Trace test for co-integrating vectors between the explained and the explanatory variables is employed to investigate the extent to which long-run steady state relationship exists between budget and current account balances. Results suggest that the existence of long run equilibrium relationship between the explained and explanatory variables cannot be rejected (r ≠ o) for Nigeria. Results of long run granger causality estimation indicate evidence of twin deficits hypothesis for Nigeria. This suggests that, in the long run, fiscal deficits fuel current account imbalance in Nigeria. Results of short run granger causality estimation indicate no evidence of both the twin deficits phenomenon and current account targeting scenario, which suggests that the Ricardian equivalence proposition (REP) holds for Nigeria in the short run. This concept is of the view that since people are rational, they know that the reduction in taxes, resulting from the government expansionary fiscal policy of tax cut or increase in public debt, is temporal and will save their extra disposable income to meet the expected future higher taxes obligations. This suggests that the national savings position will be sustained because the decrease in government savings represented by increased fiscal deepening will be equitably compensated for by the additional precautionary private savings for expected future increase in taxes. This designates fiscal balance variable as exogenous to current account balance model and indicates lack of responsiveness of private consumption to fiscal impulse in the short run. This by implication casts doubts on the efficacy of the use of fiscal policy in the management of external balance and suggests that fiscal policy should not be intended for improvement in current account balance or in the least, should not be used in isolation to supervise developments in current account stance of Nigeria in the short run. But in the long run, policy maker should embrace such policies that would encourage fiscal consolidation to correct the persistent current account imbalance.
This study aims to analyze the validity of twin deficit hypothesis in European Union
countries. In order to achieve this purpose, Granger causality test was performed to the
variables of budget deficit and current account deficit. In this study, 17 European Union
countries were included and annual data for the period between 1994 and 2014 was used.
According to the results of this study, it was determined that twin deficit hypothesis is
valid for 4 European Union countries (Finland, England, Spain and Hungary). However, it
was also defined that there is not any relationship between budget deficit and current
account deficit for other 13 countries. Therefore, we could not reach a definite conclusion
related to twin deficit hypothesis for European Union countries. Because of this situation,
it is thought that while analyzing this hypothesis, specific conditions for countries should
be taken into the consideration.
Over the past three decades, the twin deficits hypothesis (TDH) — that budget deficit has a direct effect on current account deficit — has been a topic of interest in the empirical literature (see, for example, Bahmani-Oskooee, 1995; Khalid & Guan, 1999; Mohammadi, 2004; Bagnai, 2006; Salvatore, 2006; Bartolini & Lahiri, 2006; Baharumshah & Lau, 2007; Ito, 2009; Daly & Siddiki, 2009). The causal link between public budget deficit and current account balance has been analyzed extensively in the recent literature, largely because of its implications for long-term economic progress. For small, open economies that depend heavily on foreign capital, an adverse change in foreign investors’ behavior may trigger a series of sharp and disorderly adjustments of external imbalances that, in turn, have serious consequences on the economy (see, for example, Milesi-Ferretti & Razin, 1998; Chinn & Prasad, 2003). In an influential paper, Rodrik (1999) warned: ‘Openness to capital inflows can be especially dangerous if appropriate controls, regulatory apparatus and macroeconomic frameworks are not in place.’ (p. 30).1 From a theoretical viewpoint, fiscal expansion could worsen the current account balance and the appreciation of the real exchange rate (Salvatore, 2006).2 These imbalances may hinder economic growth and undermine a nation’s wealth creation.
Abstract This study proposes an alternative analytical framework for testing the so-called twin deficits hypothesis from the general equilibrium perspective. The income-expenditure equilibrium takes both the behavioural relationships of the saving and investment into consideration. The empirical results of cointegration tests show that the US fiscal balance, current account balance, real income and interest rates (short- and long-run) are co-movement for the observed periods between 1970Q2 and 2011Q4. Also, the causality tests suggest that budget deficit does indirectly Granger-cause current account deficit via short-run interest rate and real income. The real income and interest rates variables determining the behavioural relationships are important in understanding the US twin deficit slogan. In short, the empirical results validate the twin deficits hypothesis in the USA. Some policy implications have been drawn, especially on the implementation of the "fiscal cliff" policy. This study also recommends portfolio balance approach for future twin deficits research.
Fiscal policy of the current decade in many respects mirrors the fiscal policy of the 1980s. This is particularly true in that growing budget deficits are reflected in growing current account deficits. The twin deficits are back!" Jeffrey Frankel (2004), Harvard University Rising federal government budget deficit and current account deficits in the United States and elsewhere have sparked heightened interest in the impact of domestic and foreign deficits on the growth potentials of the domestic economy. The purported link between an economy's current account deficit and its budget deficit was the subject of considerable policy debate and empirical testing in the early 1990s. The traditional view (also referred to as the Keynesian proposition) is that when an economy is operating at below full employment capacity, a budget deficit spurs all components of aggregate demand including demand for imports. Providing that exports do not increase proportionately to offset increased imports, budget deficits significantly increase external deficits. Adherents of this view point out that a large budget deficit raises domestic interest rates and hence the exchange rate. Thus, a combination of a higher interest rate and a stronger currency help to "drive the trade and current account of the balance of payments into deficit." Despite its theoretical appeal, the conventional view of the relationship between the two deficits is not broadly shared. Many researchers have invoked the Ricardian equivalence hypothesis to argue that budget deficits mainly result from tax cuts that tend to reduce both public revenues and public savings. While these tax cuts have the effect of reducing public savings and enlarging the budget deficit, they increase private savings by an equivalent amount. Proponents of this view argue that alterations in the composition of public financing, (i. e debt versus taxes) have no effect on real interest rates, aggregate demand and private spending. This paper investigates the topic using data from an "under-researched" region of the world consisting of Egypt, Iran, Jordan, Kuwait, Morocoo, Oman, Syria, Turkey and Yemen.
This article explores the dynamic relationship between budget and trade deficits (twin deficits) observed in several middle-eastern and North African economics in recent decades. From a policy viewpoint, it matters greatly to ascertain whether the twin deficits hypothesis holds in general or it has limited validity for a handful of countries over selected time periods. The objective of our research is to test the hypothesis for several countries including Bahrain, Egypt, Iran, Jordan, Kuwait, Morocco, Oman, Nigeria, Syria, Tunisia, Turkey and Yemen in the Middle East subcontinent. Compared to Europe and North America, this important area of the world remains largely under-researched. The structural vector autoregression (VAR) is used to test the hypothesis that innovations in government budget deficit are positively transmitted to trade deficit. Our empirical findings suggest that the incidence of twin deficits appears to be country specific. The observed cross-country variations with regard to the effects of fiscal deficits on current account deficits tend to confirm that the dynamic relationship between the two deficits is subject to change depending on the underlying tax system, trade patterns and barriers, monetary regimes, the exchange rate and a complex host of internal and international forces that shape a country's economic status in the global economy. Our findings confirm that the presence and the direction of causality between the two deficits is generally country specific and ambiguous in certain cases.
Over the next thirty years, the percentage of people who are 65 and over will grow rapidly while the percentage of people in their working years will decline. This shift in the age distribution of the population will put enormous pressure on social security systems in the United States, Germany, and Japan as the number of workers whose payroll taxes fund each retiree drops sharply.
This paper assesses some of the explanations that have been put forward for the global pattern of current account imbalances that has emerged in recent years: in particular, the large U.S. current account deficit and the large surpluses of the Asian developing economies. Based on the approach developed by Chinn and Prasad (2003), we use data for 61 countries during 1982-2003 to estimate panel regression models for the ratio of the current account balance to GDP. We find that a model that includes as its explanatory variables the standard determinants of current accounts proposed in the literature--per capita income, relative growth rates, the fiscal balance, demographic variables, and economic openness--can account for neither the large U.S. deficit nor large Asian surpluses of the 1997-2003 period. However, when we include a variable representing financial crises, which might be expected to restrain domestic demand and boost the current account balance, the model explains much of developing Asia's swing into surplus since 1997. Even so, the model cannot explain why the capital outflows associated with Asia's current account surpluses were channeled primarily into the U.S. economy. Observers have pointed to strong growth performance and a favorable institutional environment as elements attracting foreign investment into the United States, and we found strong evidence that good performance in these areas significantly reduces the current account balance. While a model incorporating these factors still fails to predict the large U.S. current account deficit (and, in fact, predicts a slight surplus), it does predict a U.S. current account balance that is relatively weaker than the aggregate balance of developing Asia.
The stabilization of economic activity in the mid 1980s has received considerable attention. Research has focused primarily on the role played by milder economic shocks, improved inventory management, and better monetary policy. This paper explores another potential explanation: financial innovation. Examples of such innovation include developments in lending practices and loan markets that have enhanced the ability of households and firms to borrow and changes in government policy such as the demise of Regulation Q. We employ a variety of simple empirical techniques to identify links between the observed moderation in economic activity and the influence of financial innovation on consumer spending, housing investment, and business fixed investment. Our results suggest that financial innovation should be added to the list of likely contributors to the mid-1980s stabilization.
One purpose of this report then is to look at past current and projected numbers proportions and growth rates of older populations. Older populations also have increased because of worldwide improvements in health services educational status and economic development. The characteristics of older people are likely to be increasingly heterogeneous within nations. A second purpose of An Aging World: 2008 is to summarize socioeconomic statistics for both developed and developing nations. Comparable data are included for as many as 52 nations when the categories are reasonably consistent. In 2008 these 52 nations (Appendix Table B-1) contained 77 percent of the world’s total population. (Excerpt)
The assumption that government bonds are perceived as net wealth by the private sector is crucial in demonstrating real effects of shifts in the stock of public debt. In particular, the standard effects of “expansionary” fiscal policy on aggregate demand hinge on this assumption. Government bonds will be perceived as net wealth only if their value exceeds the capitalized value of the implied stream of future tax liabilities. This paper considers the effects on bond values and tax capitalization of finite lives, imperfect private capital markets, a government monopoly in the production of bond “liquidity services,” and uncertainty about future tax obligations. It is shown within the context of an overlapping-generations model that finite lives will not be relevant to the capitalization of future tax liabilities so long as current generations are connected to future generations by a chain of operative intergenerational transfers (either in the direction from old to young or in the direction from young to old). Applications of this result to social security and to other types of imposed intergenerational transfer schemes are also noted. In the presence of imperfect private capital markets, government debt issue will increase net wealth if the government is more efficient, at the margin, than the private market in carrying out the loan process. Similarly, if the government has monopoly power in the production of bond “liquidity services,” then public debt issue will raise net wealth. Finally, the existence of uncertainty with respect to individual future tax liabilities implies that public debt issue may increase the overall risk contained in household balance sheets and thereby effectively re-duce household wealth.
This paper develops a two-country micro-theoretic model consistent with the Ricardian equivalence hypothesis. Specifically, tax increases used to retire government debt will not affect private spending or the current account balance. However, increases in government spending, regardless of the means of finance, can be expected to induce a current account deficit. An unconstrained vector autoregression shows some patterns in the recent U.S. data that appear to be inconsistent with the Ricardian equivalence hypothesis. Rigorous testing of the model, however, does not allow the authors to reject the independence of the record federal government budget and current account deficits. Copyright 1990 by MIT Press.
Business investment in equipment surged in the 1990s, then fell back sharply after mid-2000. A popular explanation of these trends holds that the soaring stock market and declining computer prices of the last decade encouraged excess investment, setting the stage for the retrenchment that followed. Yet an analysis of the factors underlying investment suggests that capital spending patterns in the late 1990s would have been quite similar had stock values and equipment prices remained near their recent historical averages.
This paper surveys the literature on the macroeconomic effects of government debt. It begins by discussing the data on debt and deficits, including the historical time series, measurement issues, and projections of future fiscal policy. The paper then presents the conventional theory of government debt, which emphasizes aggregate demand in the short run and crowding out in the long run. It next examines the theoretical and empirical debate over the theory of debt neutrality called Ricardian equivalence. Finally, the paper considers the various normative perspectives about how the government should use its ability to borrow.
The Challenges of Narrowing the U.S.Current Account Deficit
- Economic Organisation
- Co
Organisation for Economic Co-operation and Development. 2004. “The Challenges of Narrowing the U.S.Current Account Deficit.”OECD Economic Outlook,no.75,June:29-52
Policies for an Aging Society: Recent Measures and Areas for Further Reform Organisation for Economic Cooperation and Development, Economics Department Working Paper no
- Bernard Casey
- Howard Oxley
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