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Verification of Causality through VAR and Intervention Analysis: Econometric Modeling on Budget Deficit and Trade Deficit in Nepal

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  • Shankar Prasad Acharya

    ()
    (Nepal Rastra Bank)

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    Abstract

    Direction of causality between budget deficit and trade deficit, which is popularly known as Twin Deficit Hypothesis (TDH), has been tested in this paper covering the period 1964-2004. Stationarity, co-integration, and error correction tests have been performed as fundamental groundwork on real-term datasets. Datasets are found to be stationary at first difference. Long-run relationship (co-integration) among model variables is found at first difference. Long-run stability has been supported since short-run dynamics indicated converging pattern. Residual tests and conventional Granger Causality tests suggested trade deficit has been Granger Caused by the budget deficit. This initial gesticulation has further been reinforced by the vector autoregressive (VAR) modeling and intervention analysis (impulse response function and variance decomposition) also as it has reconfirmed unidirectional causality from budget deficit to trade deficit indicating need of a policy revisit regarding efficient public expenditure management, export-led growth and strategic capital formation with the help of revised fiscal, monetary and financial policies in the present globalization context.

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    Bibliographic Info

    Article provided by Nepal Rastra Bank, Research Department in its journal NRB Economic Review.

    Volume (Year): 21 (2009)
    Issue (Month): (April)
    Pages: 1

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    Handle: RePEc:nrb:journl:v:21:y:2009:p:1

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    1. Les Oxley & David Greasley, 1998. "Vector autoregression, cointegration and causality: testing for causes of the British industrial revolution," Applied Economics, Taylor & Francis Journals, vol. 30(10), pages 1387-1397.
    2. Kawai, Masahiro & Maccini, Louis J, 1995. "Twin Deficits versus Unpleasant Fiscal Arithmetic in a Small Open Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 639-58, August.
    3. Perron, P., 1994. "Further Evidence on Breaking Trend Functions in Macroeconomic Variables," Cahiers de recherche 9421, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
    4. Steven N. Durlauf & Peter C.B. Phillips, 1986. "Trends Versus Random Walks in Time Series Analysis," Cowles Foundation Discussion Papers 788, Cowles Foundation for Research in Economics, Yale University.
    5. Miller, Stephen M, 1991. "Monetary Dynamics: An Application of Cointegration and Error-Correction Modeling," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(2), pages 139-54, May.
    6. Thomas Palley, 2001. "The Case Against Budget Surpluses," Challenge, M.E. Sharpe, Inc., vol. 44(6), pages 13-27, November.
    7. Carlos Fonseca Marinheiro, . "Ricardian Equivalence: An Empirical Application to the Portuguese Economy," International Economics Working Papers Series ces0112, Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics.
    8. Shrestha, Min B. & Chowdhury, Khorshed, 2005. "Sequential Procedure for Testing Unit Roots in the Presence of Structural Break in Time Series Data," Economics Working Papers wp05-06, School of Economics, University of Wollongong, NSW, Australia.
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