Twin deficits: new evidence from a developing (oil vs. non-oil) countries’ perspective

Abstract

We test the relationship between the current account and fiscal policy for a group of small open developing economies with fixed exchange rates some of which are oil exporters. Specifically, we test the viewpoint of a Ricardian infinite-horizon representative agent model in which lower public savings are met by equal increases in private savings, and as a result the current account does not respond to the changes in government spending, against a Keynesian’s conventional viewpoint in which a fall in public savings has an adverse effect on the current account balance. Unlike the evidence from flexible exchange rate economies provided by many authors such as Rosensweig and Tallman (Econ Inq 31(4):580–594, 1993), Erceg et al. (Int Finance 8(3):363–397, 2005) and Saleh et al. (South Asia Econ J 6(2):221–239, 2005), the evidence from a panel data analysis and Granger-causality test of these fixed exchange-based countries supports the conventional theory of positive relationship between fiscal and external balances, with causality running from the former to the latter, in oil countries, whereas it supports the Ricardian view for non-oil countries.