Are Budget and Current Account Deficits Twins in Turkey? Evidence from Residual-based Fourier Cointegration and Fourier Causality Analyses

Abstract

This paper explores the relationship between the Turkish fiscal and current account balances with quarterly data spanning through 2006:1-2020:2 and adopting residual-based Fourier cointegration (or Fourier Engle-Granger, FEG) and Fourier Granger causality approaches. The findings from the FEG estimations suggest that budget and current account balances are cointegrated under smooth breaks in the series. More specifically, an improvement in the fiscal balance leads also to an amelioration in the current account balance - an outcome in line with the twin deficit hypothesis. In addition, a Fourier Granger causality analysis is performed for robustness check purposes. The findings are consistent with those from the FEG tests, which imply that a one-way causality running from the fiscal to the external balance is proved to be the case under smooth structural changes.