‘Twin Deficits’ Hypothesis

Anantha Ramu M.R.

Foreign Trade Review, 2017, vol. 52, issue 1, 15-29

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.

Keywords: fiscal deficit; current account deficit; VEC; structural VAR (search for similar items in EconPapers)
JEL-codes: C32 E62 F32 (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:sae:fortra:v:52:y:2017:i:1:p:15-29

DOI: 10.1177/0015732516650825

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