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‘Twin Deficits’ Hypothesis

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  • Anantha Ramu M.R.

Abstract

Higher and persistent level of fiscal deficit and current account deficit is the problem of the day for Indian economy. There exists an argument that higher fiscal deficit is the major factor behind worsening balance of payments position. However, there is no identical perception on the relationship between fiscal deficit and current account deficit both theoretically and empirically. Hence this article is a revisit to the existing debate to see whether fiscal deficit and current account deficit can be called as ‘twin deficits’ pertaining mainly to Indian economy. Using long-term annual data for the period 1980–1981 to 2012–2013 on Indian economy and using vector error correction method, this article seeks to prove that there exists long-term positive association between fiscal deficit and current account deficit, and hence can be called as ‘twins’. Using structural VAR method it has been proved here that fiscal deficit is in line with the pattern illustrated in Keynesian absorption theory and Mundell–Fleming model in regard to its impact on current account deficit. This article negates the relevance of Ricardian equivalence theory in Indian context.

Suggested Citation

  • Anantha Ramu M.R., 2017. "‘Twin Deficits’ Hypothesis," Foreign Trade Review, , vol. 52(1), pages 15-29, February.
    • Handle: RePEc:sae:fortra:v:52:y:2017:i:1:p:15-29
    DOI: 10.1177/0015732516650825
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    References listed on IDEAS

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    1. Suranjali Tandon, 2014. "Trade Balance and the Real Exchange Rate," Foreign Trade Review, , vol. 49(2), pages 117-139, May.
    2. Ashok Parikh & Bill Rao, 2006. "“Do Fiscal Deficits Influence Current Accounts? A Case Study of India”," Review of Development Economics, Wiley Blackwell, vol. 10(3), pages 492-505, August.
    3. Anoruo, Emmanuel & Ramchander, Sanjay, 1998. "Current account and fiscal deficits: Evidence from five developing economies of Asia," Journal of Asian Economics, Elsevier, vol. 9(3), pages 487-501.
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    More about this item

    Keywords

    fiscal deficit; current account deficit; VEC; structural VAR;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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