An Empirical Analysis of the Ricardian Equivalence, Feldstein-Horioka Puzzle and Twin Deficits Hypothesis in Bangladesh

Abstract

This paper analyses the possibility of the twin deficits hypothesis existing in the context of Bangladesh. The novelty of this paper lies in its approach to link and check the validity of the twin deficits hypothesis in light of the Ricardian equivalence hypothesis and the Feldstein-Horioka puzzle based on annual time-series data stemming from 1990 to 2017. Fully-Modified Ordinary Least Squares (FMOLS) estimator, Vector Error-Correction Modeling and Granger causality estimating techniques are applied to provide statistical evidence regarding the nature of the simultaneity of the twin deficits. The corresponding results, although refuting the Ricardian equivalence hypothesis in the country, suggest in favour of rejection of the twin deficits hypothesis as perceived from a negative unidirectional reverse causality running from current account deficit to Bangladesh’s fiscal shortfalls. Thus, our results impose key challenges and policy implications for the government to take into consideration with respect to simultaneous reduction in these two macroeconomic deficits.