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The twin deficits in OECD countries: cointegration analysis with regime shifts

  • Vince Daly
  • Jalal Siddiki

We investigate the question of whether or not government budget deficits and real interest rates have a long-run relationship with the current account of the balance of payments in 23 Organization for Economic cooperation and Development (OECD) countries. Such an investigation is important, since large and persistent budget deficits may impose strains on the foreign exchange markets and are considered by some to be one of the main causes of crises in international financial markets. We permit regime shifts in the cointegration analysis, which extends empirical modelling relative to existing studies. We find that the admission of regime shifts substantially influences the empirical conclusions: we find a long-run relationship between budget deficits, real interest rate and current account deficit in 13 out of 23 countries, whereas the number of countries with apparent long-run relationships is dramatically reduced when regime shifts are not permitted. We argue that, when structural breaks are taken into account, it seems to be the countries with a more extensive financial infrastructure in which the twin deficits are less likely to be conjoined.

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Article provided by Taylor & Francis Journals in its journal Applied Economics Letters.

Volume (Year): 16 (2009)
Issue (Month): 11 ()
Pages: 1155-1164

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Handle: RePEc:taf:apeclt:v:16:y:2009:i:11:p:1155-1164
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  1. 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.
  2. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
  3. Menzie D. Chinn & Eswar S. Prasad, 2000. "Medium-Term Determinants of Current Accounts in Industrial and Developing Countries: An Empirical Exploration," NBER Working Papers 7581, National Bureau of Economic Research, Inc.
  4. Ahmed M. Khalid & Teo Wee Guan, 1999. "Causality tests of budget and current account deficits: Cross-country comparisons," Empirical Economics, Springer, vol. 24(3), pages 389-402.
  5. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  6. Ghatak, Anita & Ghatak, Subrata, 1996. "Budgetary deficits and Ricardian equivalence: The case of India, 1950-1986," Journal of Public Economics, Elsevier, vol. 60(2), pages 267-282, May.
  7. Jeffrey A. Rosensweig & Ellis W. Tallman, 1991. "Fiscal policy and trade adjustment: are the deficits really twins?," Working Paper 91-2, Federal Reserve Bank of Atlanta.
  8. Allan w. Gregory & Bruce E. Hansen, 1992. "residual-Based Tests for Cointegration in Models with Regime Shifts," Working Papers 862, Queen's University, Department of Economics.
  9. Anita Ghatak & Subrata Ghatak, . "Budgetary Deficits and Ricardian Equivalence: The Case of India, 1950-1986," Discussion Papers in Public Sector Economics 96/3, Department of Economics, University of Leicester.
  10. Roberto Ricciuti, 2003. "Assessing Ricardian Equivalence," Journal of Economic Surveys, Wiley Blackwell, vol. 17(1), pages 55-78, February.
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