Untangling the causal relationship between government budget and current account deficits in OECD countries: Evidence from bootstrap panel Granger causality

Abstract

This study examines the causal relationship between the current account deficit and government budget deficit for eleven OECD countries by employing the panel Granger causality analysis. The econometric methodology used in this paper allows us to untangle the causal nexus between the current account deficit and government budget deficit and helps us to discriminate between competing theories on which hypothesis is applicable to these OECD countries. Among the main results, it is found that the Barro–Ricardo Equivalence hypothesis is applicable to France and the UK. When bootstrap critical values are used, our empirical findings indicate that there is bi-directional causality between the current account deficit and the government budget deficit for eleven OECD countries. The twin deficits hypothesis is supported either through the Keynesian hypothesis or through the current account targeting hypothesis.