Fiscal policy and trade adjustment: are the deficits really twins?
Since the mid 1980s, an extensive empirical literature has examined the relationship between U.S. fiscal deficits, exchange rates, and trade balances. The authors investigate two questions that continue to spark debate: do increased government deficits cause dollar appreciation, and do fiscal deficits lead to higher trade deficits (the popular 'twin deficit'notion)? They examine these issues using a five-variable vector autoregressive system, generating posterior probability bounds to assess significance. The authors' results provide some evidence that growing government deficits appreciate the dollar and support the twin deficit notion that government deficits contribute to trade deficits. Copyright 1993 by Oxford University Press.
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