Effects of Budget Deficit on Current Account Balance: Analysis of Twin Deficits Hypothesis in Case of Turkey

Abstract

There are generally two different views that explain development process of Twin deficits. The first approach that tries to explain “Twin Deficits Hypothesis” is Conventional Keynesian Approach and the other one is Ricardian Equivalence Approach. While the Conventional Keynesian proposition claims that budget deficits led to current account deficits, on the other hand the Ricardian Equivalence Hypothesis claims that there is no relationship between the budget deficits and current account deficits. In this paper the relationship between foreign trade balance and current account balance is researched by using annual data for 1975 and 2010 periods in Turkey. In order to search the direction and size of the association between analyzed variables, Johansen cointegration and error correction model have been employed. The empirical findings of the study reveal that for the concerning period, it is found that there is a relationship between budget deficits and current account deficits in both the short and long run. These results support the Conventional Keynesian Theory and refuse the Ricardian Equivalence Hypothesis.