Transnational investigation of factors affecting twin deficit

Abstract

“Twin deficits” is a shorthand macroeconomic term for two economic problems that are strongly linked, the current account (or international trade) deficit and the government budget deficit. After the great recession of 2008, many economies worldwide were stuck with the challenge of budget deficit reduction as well as the prevention of re-emergence of large and persistent current account deficits. It was keenly observed whether reducing budget deficit alone would help in limiting the external imbalances. Twin deficit hypothesis asserts that an increase in the budget deficit can cause an increase in the current account deficit. However, there have been different results obtained while testing this hypothesis across different countries. In India, twin deficits have been persistent in the economy for past few decades. The high fiscal deficit during the 1980’s and the large current account deficit and the decreasing domestic savings combined with inadequate borrowings from abroad was one of the prime reasons for the 1991 crisis. The below equation: (S-I) + (T-G) = (NX) Here ‘I’ is the investment, G is government spending, C is consumption, S is savings, net exports (NX) and T is the tax. Here T-G if negative can relate to a strong budget deficit. Suppose if the budget deficit increases and the savings remain the same, then either investment should fall or net exports should fall, causing a trade deficit. This leads to twin deficit. Scope of work:- The project tries to establish a causal relationship between the fiscal and current account deficit by analyzing the effect of other macroeconomic parameters of all countries listed in world bank database across a time period of 25 years from 1990-2014. Since the data of most of the countries outside this time period is not available in the World Bank and IMF database we restrict our studies to this period. Objective:- This project aims to find out the significant macroeconomic parameters that establish causal relationship between fiscal and current account deficit and hence to create a model to substantiate the findings. This project also studies the effect of various government policies, economic status and development in different countries over a period, which had an impact on this causal relationship.