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Budget Deficit Persistence and the Twin Deficits Hypothesis

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Author Info
Michel Normandin () (Center for Research on Economic Fluctuations and Employment, UQAM)

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Abstract

This paper gauges the causal relationship between external and budget deficits by using Blanchard's overlapping generations model. This model sests the twin deficits hypothesis (i.e. there is a positive relationship between the deficits) and the Ricardian equivalence hypothesis (i.e. there is no link between the deficits). This model also implies that consumers forecast future budget deficits using (at least) the history of the two deficits. This implication is used to derive time series restrictions, which are testable for given comsumer's planning horizons. For the relevant horizon, the response of the external deficit to an increase in the budget deficit is computed. For the Canadian and the U.S. economies, the relevant horizons can be as long as 83 years. However, given the persistence of the budget deficits, these horizons produce responses that are statistically significant. These findings reconcile the mixed results obtained in previous analyses.

Cette étude évalue la relation de causalité entre les déficits extérieur et budgétaire à partir du modèle de générations imbriquées proposé par Blanchard (1985). Ce modèle emboîte l'hypothèse des déficits jumeaux (i.e. il y a une relation positive entre les déficits) et l'hypothèse d'équivalence ricardienne (i.e. il n'y a aucun lien entre les déficits). Aussi, ce modèle implique que les consommateurs prévoient les déficits budgétaires futurs en considérant l'évolution des deux déficits. Cette implication permet de dériver des restrictions pouvant être testées pour certains horizons de planification des consommateurs. Pour les horizons pertinents, la réponse du déficit extérieur à une augmentation du déficit budgétaire est calculée. Pour les économies canadienne et américaine, les horizons pertinents peuvent être aussi longs que 83 ans. Compte tenu de la persistance des déficits budgétaires, ces horizons procurent toutefois des réponses qui sont statistiquement significatives. Ces réponses réconcilient les résultats obtenus dans les études précédentes.

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Publisher Info
Paper provided by CREFE, Université du Québec à Montréal in its series Cahiers de recherche CREFE / CREFE Working Papers with number 31.

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Length: 32 pages
Date of creation: Dec 1994
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Handle: RePEc:cre:crefwp:31

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Related research
Keywords: budget and external deficits cointegartion tests planning horizon Ricardian equivalence unit roor tests Wald tests

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Find related papers by JEL classification:
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. David Johnson, 1986. "Consumption, Permanent Income, and Financial Wealth in Canada: Empirical Evidence on the Intertemporal Approach to the Current Account," Canadian Journal of Economics, Canadian Economics Association, vol. 19(2), pages 189-206, May. [Downloadable!] (restricted)
  2. Evans, Paul, 1993. "Consumers Are Not Ricardian: Evidence from Nineteen Countries," Economic Inquiry, Oxford University Press, vol. 31(4), pages 534-48, October.
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    Other versions:
  4. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January. [Downloadable!] (restricted)
  5. Ahmed, Shaghil, 1987. "Government spending, the balance of trade and the terms of trade in British history," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 195-220, September. [Downloadable!] (restricted)
  6. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April. [Downloadable!] (restricted)
    Other versions:
  7. Haug, Alfred A, 1990. "Ricardian Equivalence, Rational Expectations, and the Permanent Income Hypothesis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 22(3), pages 305-26, August. [Downloadable!] (restricted)
  8. Nouriel Roubini, 1988. "Current Account and Budget Deficits in an Intertemporal Model of Consumption and Taxation Smoothing. A Solution to the "Feldstein-Horioka Puzzle"?," NBER Working Papers 2773, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  9. Poterba, James M. & Summers, Lawrence H., 1987. "Finite lifetimes and the effects of budget deficits on national saving," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 369-391, September. [Downloadable!] (restricted)
    Other versions:
  10. Enders, Walter & Lee, Bong-Soo, 1990. "Current Account and Budget Deficits: Twins or Distant Cousins?," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 373-81, August. [Downloadable!] (restricted)
  11. Hansen, Lars Peter & Sargent, Thomas J., 1980. "Formulating and estimating dynamic linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 2(2), pages 7-46, May. [Downloadable!] (restricted)
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  12. Campbell, John Y & Deaton, Angus, 1989. "Why Is Consumption So Smooth?," Review of Economic Studies, Blackwell Publishing, vol. 56(3), pages 357-73, July. [Downloadable!] (restricted)
  13. Hercowitz, Zvi, 1986. "On the determination of the external debt: The case of Israel," Journal of International Money and Finance, Elsevier, vol. 5(3), pages 315-334, September. [Downloadable!] (restricted)
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    Other versions:
  15. Evans, Paul & Hasan, Iftekhar, 1994. "Are consumers Ricardian? Evidence for Canada," The Quarterly Review of Economics and Finance, Elsevier, vol. 34(1), pages 25-40. [Downloadable!] (restricted)
  16. Leiderman, Leonardo & Razin, Assaf, 1988. "Testing Ricardian Neutrality with an Intertemporal Stochastic Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(1), pages 1-21, February. [Downloadable!] (restricted)
  17. Reuven Glick & Kenneth Rogoff, 1992. "Global versus country-specific productivity shocks and the current account," Working Papers in Applied Economic Theory 92-06, Federal Reserve Bank of San Francisco.
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  18. Gregory, Allan W & Veall, Michael R, 1985. "Formulating Wald Tests of Nonlinear Restrictions," Econometrica, Econometric Society, vol. 53(6), pages 1465-68, November. [Downloadable!] (restricted)
  19. Ahmed, Shaghil, 1986. "Temporary and permanent government spending in an open economy: Some evidence for the United Kingdom," Journal of Monetary Economics, Elsevier, vol. 17(2), pages 197-224, March. [Downloadable!] (restricted)
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    Other versions:
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Christopher Erceg & Luca Guerrieri, 2005. "Expansionary Fiscal Shocks and the Trade Deficit," Computing in Economics and Finance 2005 128, Society for Computational Economics. [Downloadable!]
    Other versions:
  2. Christiane Nickel & Katja Funke, 2006. "Does Fiscal Policy Matter for the Trade Account? A Panel Cointegration Study," IMF Working Papers 06/147, International Monetary Fund. [Downloadable!]
  3. Michel Normandin, 2004. "Econometric Inference, Cyclical Fluctuations, and Superior Information," Cahiers de recherche 04-13, HEC Montréal, Institut d'économie appliquée. [Downloadable!]
  4. Ahmad Zubaidi Baharumshah & Evan Lau & Ahmed M. Khalid, 2005. "Testing Twin Deficits Hypothesis: Using VARs and Variance Decomposition," International Finance 0504001, EconWPA. [Downloadable!]
  5. Martin Boileau & Michel Normandin, 2004. "The Current Account and the Interest Differential in Canada," Cahiers de recherche 0424, CIRPEE. [Downloadable!]
    Other versions:
  6. Ahmad Zubaidi Baharumshah & Evan Lau, 2005. "Budget and Current Account Deficits in SEACEN Countries: Evidence Based on the Panel Approach," International Finance 0504002, EconWPA. [Downloadable!]
  7. Michel Normandin & Martin Boileau, 2003. "Dynamics of the Current Account and Interest Differentials," Cahiers de recherche 03-05, HEC Montréal, Institut d'économie appliquée. [Downloadable!]
    Other versions:
  8. Lau, E. & Baharumshah, A. Z., 2006. "Twin Deficits Hypothesis in SEACEN Countries: A Panel Data Analysis of Relationships between Public Budget and Current Account Deficits," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 6(2). [Downloadable!] (restricted)
  9. Michel Normandin, 2006. "Fiscal Policies, External Deficits, and Budget Deficits," Cahiers de recherche 0632, CIRPEE. [Downloadable!]
  10. Abdulnasser Hatemi-J & Ghazi Shukur, 2002. "Multivariate-based causality tests of twin deficits in the US," Journal of Applied Statistics, Taylor and Francis Journals, vol. 29(6), pages 817-824, August. [Downloadable!] (restricted)
  11. Martin Boileau & Michel Normandin, 2001. "Labor Hoarding, Superior Information and Business Cycle Dynamics," Cahiers de recherche CREFE / CREFE Working Papers 129, CREFE, Université du Québec à Montréal. [Downloadable!]
    Other versions:
  12. Jocelyn Horne, 2001. "The Current Account Debate in Australia: Changing Policy Perspectives," Research Papers 0111, Macquarie University, Department of Economics. [Downloadable!]
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