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Testing Twin Deficits Hypothesis: Using VARs and Variance Decomposition

  • Ahmad Zubaidi Baharumshah

    (UPM)

  • Evan Lau

    (UNIMAS)

  • Ahmed M. Khalid

    (Bond University)

This paper examines the twin deficits hypothesis in Indonesia, Malaysia, the Philippines and Thailand (ASEAN-4 countries). The major findings of this paper are: (1) Long run relationships are detected between budget and current account deficits. (2) We found that the Keynesian reasoning fits well for Thailand since a unidirectional relationship exists which runs from budget deficit to current account deficit. For Indonesia the reverse causation (current account targeting) is detected while the empirical results indicate that a bidirectional pattern of causality exists for Malaysia and the Philippines. (3) We also found support for an indirect causal relationship that runs from budget deficit to higher interest rates, and higher interest rates lead to the appreciation of the exchange rate and this leads to the widening of current account deficit. (4) The results of the variance decompositions and impulse response functions suggest that the consequences of large budget and current account deficits become noticeable only over the long run.

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Paper provided by EconWPA in its series International Finance with number 0504001.

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Date of creation: 01 Apr 2005
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Handle: RePEc:wpa:wuwpif:0504001
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