Twin Deficits Research Articles

Investigating locational asymmetry in the twin deficit hypothesis for the WAMZ countries

ABSTRACT The study adopts the Quantile Autoregressive Distributed Lags (QARDL) method to examine the existence of locational asymmetry in the nexus between fiscal and current account deficits in the WAMZ zone. Results of the long run relationships using both variables as dependent variables, rejected the null hypotheses of parameter constancy across the quantiles, and established the variability of a twin deficit hypothesis across different quantiles. In the short run, the Keynesian view is validated for Gambia, Ghana, and Nigeria, whereas Serria Leone, Ghana, and Liberia indicated the Ricardian equivalence framework, suggesting the acceptance of twin divergence hypothesis. In addition, a causality analysis finds robust bi-directional causal evidence for the strong causal relationship along all specifications, validating the long run relationship established in the QARDL cointegration tests.

The dynamic linkages between current account deficit and budget balance deficit in the South Asian region

The issue of twin imbalances is at the forefront of fiscal policy concerns in the South Asian region, fuelled by an ever-going budget deficit and current account deficit over the last five decades. A standard approach is to assume a model in which budget balance influences the current account. We relax this assumption by using a panel data vector autoregression model comprising five South Asian countries. The results show that both budget deficit and current account deficit are mutually causative, which contrasts the unidirectional causality running from fiscal deficit to current account deficit found in prior studies. Further, this bi-causality relationship is also demonstrated in the impulse response analyses. Budget balance in South Asian economies responds positively to a one standard deviation positive shock in the current account balance. Likewise, external balance increases to a one standard deviation positive shock in internal balance. Higher fiscal debt impedes economic growth, which in turn impacts negatively on the budget balance. Our findings lead us to reject 'fiscal policy only' recommendations to address the twin deficits.

Dynamics of Twin Deficits, Ricardian Equivalence, and Feldstein-Horioka Puzzle in South Asian Countries

This study examines the relationship between budget deficit and current account deficit, specifically twin deficits hypothesis, Ricardian equivalence hypothesis, and Feldstein-Horioka puzzle in South Asian countries. Results show that budget deficit and private savings investment balance do not affect current account deficit in the long run and rejects the Keynesian view of twin deficits hypothesis in South Asian countries. No causality exists between current account deficit and budget deficit in India, Pakistan, and Sri Lanka in short run, while bidirectional causality exists in Bangladesh. Ricardian equivalence hypothesis is rejected in Bangladesh and Sri Lanka, while it holds in India and Pakistan. Feldstein-Horioka puzzle exists in Bangladesh and Sri Lanka, while it does not exist in India and Pakistan. Structural reforms in fiscal and trade sector are required to avoid emergence of twin deficits, while an active and effective role of government is required for sustainable economic growth.

Twin deficits revisited: A role for fiscal institutions?

We revisit the twin-deficits relationship for a sample of 65 countries with fiscal rules over the period 1985–2015, using a panel data estimation methods. Our analysis accounts for the role of various types of fiscal rules and institutions: expenditure rules, revenue rules, budget balance rules, debt rules, fiscal councils, and supporting procedures. We find that the twin-deficits hypothesis is confirmed. The impact of the budget balance on the current account balance is increased when fiscal rules are considered, except with revenue rules and debt rules. Well-designed fiscal rules, fiscal councils and features that reinforce compliance with rules improve the current account balance. Our findings highlight the role of fiscal factors in explaining sustained global current account imbalances. They also contribute to the ongoing discussion about the improvement of macroeconomic and budgetary surveillance in the European context.

Does the twin deficit hypothesis exist in India? Empirical evidence from an asymmetric non-linear cointegration approach

This paper explores the dynamic relationship between the current account deficits and fiscal deficits in India. This paper has used the very much familiar Enders and Siklos (2001) and Hansen and Seo (2002) regime-switching threshold cointegration with an asymmetric error correction approach and non-linear ARDL model developed by Shin et al. (2014) to examine the non-linearity, short and long-run asymmetry, and asymmetrical adjustment between the current account deficits and fiscal deficits in India. Initial results validate the asymmetric adjustment between current account deficits and fiscal deficits, indicating the twin divergence hypothesis. However, the posterior sensitivity analysis suggests the twin deficit hypothesis, which seems more robust. Moreover, empirical results reveal that the interaction between these deficits is asymmetrically related, and fiscal deficits' upward and downward movement substantially affect India's current account deficits in the short-run and long run. The asymmetrical lead-lag relationship between current account deficits and fiscal deficits harms the current account sustainability, balance of payments, exchange rate, bond, and financial markets. Therefore, the study argues in its policy solution that the central bank of India must try to overcome the prolonged current account deficits and maintain stability in the domestic currency.

Twin Deficit Hypothesis and Macroeconomic Fundamentals: New Evidence from Nigeria

This study tests for the validity of the twin-deficit hypothesis in Nigeria for the period 1981 – 2018 and further seeks to ascertain the role of macroeconomic fundamentals in driving this hypothesis using the non-linear autoregressive distributed lag (NARDL) model and structural vector autoregressive (SVAR) model. With evidence from granger causality test, the results obtained for the NARDL model support the validation of the twin-deficit hypothesis for the Nigerian economy. As long-run equilibrium exists, it was further established that the twin deficits were majorly driven by the degrees of financial and trade openness in Nigeria as no substantial shock effects of the twin deficits were traceable to any of the macroeconomic fundamentals. It is therefore recommended that policy makers in Nigeria should properly sequence the degree of economic openness to ensure the overall health of the economy.

The Twin Deficit Hypothesis in the MENA Region: Do Geopolitics Matter?

This paper examines the relationship between fiscal and external balances in MENA oil versus non-oil countries in the context of the twin deficits hypothesis (TDH) using Panel Vector Autoregression- Generalized Methods of Moments PVAR GMM estimation, Granger Causality and IRFs. The essence of this analysis is to assess the vulnerability of fiscal and external balances to oil price dynamics and regional geopolitics in the region. Results show that a twin-deficit problem exists in MENA oil-rich countries only while the problem does not exist in non-oil ones. This affirms the hypothesis that oil dependence results in high fiscal vulnerability to geopolitical shocks that automatically transmits to external balances. While a TDH isn’t proven to exist in non-oil countries, fiscal and external balances problems result from longstanding structural factors. A high reliance on tourism revenues and remittances as main sources of foreign currency receipts (together with poor tax administration and enlarged current spending bills) makes those countries more vulnerable to domestic and external shocks; reflected in both growing fiscal and current account deficits. A large imports sector and relatively poor exporting capacity also contribute to weakening external accounts. The main policy recommendations for MENA oil-rich countries rely in the importance of strengthening the non-oil sector in order to diversify domestic sources of revenues. Adopting flexible exchange rates is recommended to decrease the vulnerability of the external shocks to oil price dynamics. For non-oil MENA regions, fiscal consolidation, reforming current spending and strengthening tax administrations are crucial to improve fiscal performance. Export-led growth strategies and inclusive growth policies would also contribute to improving external accounts in the examined economies.

Long-run stability of money demand and monetary policy: The case of Algeria

Since the start of the oil counter-shock in June 2014, Algeria has experienced unprecedented twin deficits. The excessive monetisation of the public deficit coupled with other deep anomalies in the economy of this country acutely calls for reconsideration of its monetary policy. To this end a prior study of the long-run stability of money demand is needed. We estimate the demand for money for monetary aggregates M1 and M2, and cash in Algeria over the period 1979–2019, and study its long-run stability. We show that the transaction motive is significant for all three aggregates, especially for the demand for cash, reflecting the weight of informal economy “practices”. The elasticity of the scale variable is very close to unity for M2 and M1, and even equal to unity for cash demand (1.006). The elasticity of inflation is also significant for all three aggregates, although its level is higher in the case of cash demand (−6.474). Despite the persistence of certain financial repression mechanisms, interest rate elasticity is significant for all three aggregates, but higher for M1 and cash. The same observation is made for elasticity of the exchange rate, reflecting the effect of monetary substitution, especially for M1 and cash. Finally, our study concludes that the demand for money in terms of M1 remains stable, the same observation being confirmed for the M2 aggregate. However, the demand for fiat currency proves not to be stable. The consequences for the optimal design of monetary policy in Algeria are clearly stated.

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

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.

The twin deficits and economic growth in selected African countries

The twin deficits and economic growth in selected African countries

Analysis of Budget Deficit Phenomenon and Current Account Deficit in Indonesia (1990-2019)

This research is motivated by the occurrence of twin deficit in Indonesia that have occurred since 2012. Twin deficit is a phenomenon where the budget deficit occurs simultaneously with the current account deficit. The relationship between the government budget and the current account is explained through components in the APBN and the current account balance. Therefore, this study aims to analyze the correlation between the budget deficit and the current account deficit. This study uses time series data for the period 1990-2019, obtained from Kementrian Keuangan Republik Indonesia, Bank Indonesia and World Bank publications. The method used in this study is the Vector Error Correction Model (VECM) regression method to see the short-term and long-term relationships of budget deficit to the current account deficit. The results of this study indicate that there is a correlation between the budget deficit and the current account deficit. This is indicated by the empirical results which show that significantly the budget deficit has a correlation with the current account deficit in the short and long term. In the period 1990-1999, the budget balance and the current account showed no correlation. The current account deficit in that period was mainly due to investment patterns. The existence of a balance relationship between the budget balance and the current account is shown in the 2000-2019 period, during which Indonesia implemented a deficit budget system.

The Tragedy of Transition: Development, Deterioration, Decay. The Case of Hungary, 1990-2020

The essay is about the economic and political development of Hungary in the last 30 years. It can be neatly divided into three periods which coincide with the calendar decades almost perfectly. After the collapse of the communist system, the first period constituted a glorious decade in development: the first two governments implemented almost all indispensable structural reforms required for a successful transition. After the financial stabilization in 1995, a consistent macroeconomic policy was applied, leading to export and investment-driven, hence sustainable economic growth. The next decade brought deterioration: reforms were stalled, and a sharp turn to consumption-led and debt-fuelled growth resulted in twin deficits which, by the time of the Great Recession, almost triggered a sovereign debt default. After a short period of successful financial stabilization, a populist-nationalist government came to power in 2010. A decade of decay set in: reversal of structural reforms, nationalization, monopolization, protectionism, market-distorting taxation and subsidization, state capture by a corrupt oligarchy, together with inconsistent macroeconomic policy. In addition, the self-styled „illiberal regime” of Viktor OrbĂĄn demolished the rule of law and all institutions representing checks and balances in a democracy. Corruption was elevated to the level of official government policy. With the help of the huge amount of subsidies coming from the EU, the regime maintained financial equilibrium and achieved significant growth during the time of global boom between 2014-2019. However, given the fact that private investments and productivity stay rather low in the non-tradable sector of the domestic economy, real convergence to Western efficiency and living standards remain elusive. Today Hungary constitutes a primary example of an economy pushed into a typical middle-income trap by its oligarchic and authoritarian regime. It also proves that transition reforms are all reversible; institutions are fragile. Restoration of the rule of law and democracy seems to be an indispensable prerequisite for convergence and development.

Prevalence of twin deficits in selected European Union countries and in Poland in the years 2009-2018

The aim of the article is to determine the degree, direction and strength of impact of the studied variables, i.e. the state budget balance and the current account balance as part of Poland's balance of payments in the years 2009-2018 against the background of selected European Union (EU) countries. The main research questions focus on determining the type of relationships connecting the studied deficits in the light of previous studies dedicated to the twin deficits hypothesis. The methodology used is based on integrated correlation analysis, linear regression and an analysis of the coefficient of variation. As a result of the study, a strong correlation was found between the cumulative values of the studied deficits, which confirms the existence of the twin deficits hypothesis in Poland in the examined period and means that the budget deficit affects the current account balance. A change in the cumulative balance of the budget by 1% leads to a change in the cumulative balance of the current account of the balance of payments by 0.89%. It can be presumed that the problem of budget deficits and the related debt crisis as well as balance of payments balances under the dichotomy of "surplus north" and "deficit south" in the next decade will be one of the most conflicting and disintegrative for the EU. Thus, the search for a path to budget (internal) balance and balance of payments (external) is one of the key challenges for maintaining cohesion and maintaining sustainable development both in Poland and the entire EU.

External imbalances from a GVAR perspective

AbstractWe study the drivers governing external disequilibria through a Global VAR (GVAR) analysis applied to a group of 24 countries during the period 1972–2017. The GVAR methodology is particularly well suited for our research question. First, it permits to measure the effects of both domestic and foreign country‐specific shocks. Second, it allows us to analyse the long‐run relationships and dynamics through generalised impulse response functions. Third, it enables us to test many hypotheses from a macroeconomic perspective and the existence of spillovers. Our results show evidence of international financial integration in terms of fulfilling the real interest rate parity. Concerning the twin deficits hypothesis, we find no conclusive results. In addition, we show how German fiscal policy has relevant spillover effects on other European countries (such as France, Spain and the Netherlands) and the United States and India. Finally, global shocks have long‐lasting effects in most countries analysed, primarily through real oil prices. These results provide clues about how to implement a more symmetrical external adjustment, especially inside the euro area.

The Covid-19 pandemic and economic stimulus in India: has it been a hostage of macroeconomic complications?

ABSTRACT This paper analyzes the efficacy and skepticism surrounding the economic stimulus package announced by the Indian authorities in response to the Covid-19 pandemic in 2020. While the end of the pandemic is yet to be on the horizon, countries across the world have been undertaking economic stimulus packages of varied nature, depth, and quantum. A scrutiny of these packages show that India has been cautious in formulating policy measures and balancing inter-temporal objectives. The disaggregated economic stimulus package in India belies the justification of it being an adequate stimulus in managing the mammoth crisis, especially when the authorities had resorted to more deferred spending measures while the need of the hour was direct fiscal spending. Specifically, this study argues that the causes behind the fiscal conservativeness might be linked to India’s twin deficits in the fiscal and current account fronts, along with the fear of a potential capital flight and a possible adverse response by the foreign investors.

The Dollar and its Discontents

The dollar fell by 10 per cent between its March 2020 high and the end of the calendar year, and many banks and forecasters expect it to fall further, by as much as 35 per cent in 2021 Dollar skeptics cite the end of safe-haven flows following the approval of CO VID vaccines, the Federal Reserve's aggressive quantitative easing, America's twin deficits, and the rise of viable alternatives to the greenback This article argues, in contrast, that this dollar pessimism is overdrawn

Twin deficits hypothesis in Bangladesh: an empirical investigation

PurposeThis study attempts to examine the twin deficits hypothesis for Bangladesh. Along with the traditional twin deficits hypothesis associated with the current account and fiscal deficit, the paper also explores the causal relationship between the trade deficit and fiscal deficit.Design/methodology/approachWe start with the investigation of the conventional twin deficit hypothesis employing autoregressive distributed lag (ARDL) bounds testing approach in a multivariate framework. Due to the absence of cointegration between the budget deficit and trade deficit, the study adopts a multivariate vector autoregressive (VAR) model to analyze the nexus.FindingsThe study supports the presence of the twin deficits hypothesis in Bangladesh, both in the short run and long run. Unidirectional causation running from the budget deficit to the current account deficit in the long run. The trade model also supports the twin deficit hypothesis, like the aforementioned current account model.Practical implicationsTherefore, the sustainable fiscal deficit is the key to maintain a stable current account deficit and trade deficit in Bangladesh.Originality/valueThe study incorporates the country risk indicators to address the governance issue while analyzing the models' deficit scenarios because good governance is an integral part of explaining the development outcome and failure of a country like Bangladesh.

Cryptocurrency, Money Demand and the Mundell-Fleming Model of International Capital Mobility

If cryptocurrencies are perceived as financial innovations that could disrupt domestic and international financial systems, it becomes imperative for economists to incorporate these virtual currencies into existing money market models. Cryptocurrencies, when fully adopted by the general public, would transmit into the financial system via money demand. Cryptocurrencies serve as money and non-money assets and have no perfect substitute, whereas they are perfect substitutes for M1. Therefore, how much impact would the popularity of cryptocurrencies have on domestic and international capital mobility? To isolate interest rate differentials across countries, the Mundell-Fleming model that assumes a constant interest rate in domestic and world economies was applied. Cryptocurrencies acquired in past periods that are acceptable worldwide would abrogate exchange rate differentials. This study theoretically finds that fiscal and monetary policies would have different impacts on income in economies with high cryptocurrency circulations compared to economies with only M1. Also, there is a critical interest rate where cryptocurrencies would be more attractive to investors than other non-money assets. Moreover, using the Keynesian aggregate income and aggregate expenditure model, without interest and exchange rate differentials, the worldwide use of cryptocurrencies in international trade would unveil the link between the twin deficits and international capital flows.

On public debt and twin imbalances in the South Asian region

ABSTRACT This paper studies the impact of a country’s public debt on its twin deficits. Using panel data of five South Asian countries characterized by acute twin deficits and a high debt-to-GDP ratio for 1980–2018, we find no evidence that the budget balance wields a statistically significant impact on the current account. When the relationship between fiscal and current account deficits is conditioned on public debt levels, we find a statistically significant non-linear twin deficits relationship. For low-to-moderate debt countries with debt ratios between 46.21% and 65.80% of GDP a fiscal deficit, increase leads to a lower current account deficit. For high debt countries (i.e. debt-to-GDP ratio is above 65.80%), a rising fiscal deficit results in a larger current account deficit. Maintaining a sustainable debt-to-GDP ratio of 65.80% or lower is crucial for reducing both fiscal deficits and current account imbalances.

Macroeconomic Effects of Fiscal Consolidation in Emerging Economies: New Narrative Evidence from Latin America and the Caribbean

AbstractWe estimate the effects of fiscal consolidation on economic activity based on a new narrative data set for 14 emerging economies in Latin America and the Caribbean (LAC). Following a Romer and Romer identification approach, we examine contemporaneous policy documents to identify changes in fiscal policy motivated by a desire to reduce the budget deficit and not by responding to the economic cycle. We find that a fiscal consolidation of 1% of GDP reduces real GDP by, on average, 0.9% in two years. The estimated effects are close to those we find for advanced economies based on a comparable narrative data set. We also find a strong “twin deficits” relation in LAC, with fiscal consolidation triggering an adjustment of the current account balance and depreciation of the real exchange rate that are more pronounced than in advanced economies.