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Budget Deficit Persistence and the Twin Deficits Hypothesis

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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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  • Michel Normandin, 1994. "Budget Deficit Persistence and the Twin Deficits Hypothesis," Cahiers de recherche CREFE / CREFE Working Papers 31, CREFE, Université du Québec à Montréal.
  • Handle: RePEc:cre:crefwp:31
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    More about this item

    Keywords

    budget and external deficits; cointegartion tests; planning horizon; Ricardian equivalence; unit roor tests; Wald tests;
    All these keywords.

    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

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