Dynamics of fiscal and current account deficits in Thailand: an empirical investigation

Abstract

PurposeThe purpose of this paper is to contribute further on the twin deficits debate in a developing economy.Design/methodology/approachThe data for Thailand over three decades are used as a case study.FindingsThe major findings are: first, a stable, long‐run equilibrium relationship between fiscal deficit, interest rate, exchange rate, and current account was found. Second, the causal relationship between the two deficits runs from fiscal deficit to current account deficit. This evidence is supportive of the twin deficits hypothesis. Further econometric analysis reveals that the two financial variables (interest rate and exchange rate) act as intermediating variables – that is an increased fiscal deficit causes interest rate to rise, and this in turn puts pressure on the exchange rate. The appreciation of the domestic currency causes a current account deficit.Originality/valueThe paper is of value by showing both direct and indirect channels to uncover the twin deficits phenomena. Based on a persistent profile response, it was found that the adjustment process may take as long as a year to complete.