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We examine the twin deficits and the direction of its movement for the case of Bolivia, a natural resource-dependent country, using the database of (Kehoe et al., 2019) from 1960 to 2019.

We combine a structural vector autoregression (SVAR) model with a dynamic stochastic general equilibrium (DSGE) model to understand the transmission mechanisms.

Our results suggest the existence of twin deficits in Bolivia; however, causality in the Mundell-Fleming sense does not hold. While fiscal policy shocks explain current account deficits, current account shocks have a stronger effect over fiscal deficit. In fact, only 23% of the variance of current account forecast errors is explained by fiscal policy shocks; in contrast, 45% of the variance of the fiscal deficit is explained by current account shocks.

The study is for a specific case, which is a limitation; however, other country samples can be included.

Based on the results of the work, policies can be recommended and designed to cushion the effects of external shocks.

According to the literature available for the Bolivian case, our work constitutes a significant contribution and, therefore, is original for this specific case.

In light of Bangladesh’s economy, the goal of this study is to examine the “Twin Deficit Hypothesis (TDH),” which refers to a link between the budget deficit and the current account deficit. This study used yearly time series data from 1980 to 2020 to investigate the phenomena.

A multivariate autoregressive distributive lag (ARDL) model has been presented for empirical investigation, with the ARDL bound test investigating the co-integration between the inadequacies. As some of the variables in the bound test lack co-integration, the study adds a multivariate vector autoregressive (VAR) model later on.

With evidence of the result, the study supports the validation of twin deficit hypothesis in Bangladesh economy since both current account deficit and fiscal deficit affects each other significantly whereas Granger causality test confirms that fiscal deficit causes current account deficit but not the other way around.

The government should maintain a restrictive monetary policy in order to stabilize the current account deficit.

The novelty of this study is the incorporation of inflation, real exchange rate and GDP per capital to TDH that together form the basis for a macroeconomic snapshot of the economy.

This paper is an attempt to re-examine the validity of the Twin Deficit Hypothesis in the Indian economy, which is characterised by mounting inequality and liquidity constraints. The authors augment the econometric analysis with two important mediating variables, exchange rate and trade openness, to analyse their impact on current account deficit.

The authors have used a ground-breaking asymmetric cointegration technique proposed by Shin et al. (2014) to investigate the short-run and long-run asymmetric nexus between gross fiscal deficit and current account deficit. In addition, the study has used asymmetric dynamic multipliers to see the dynamics of nonlinear adjustment from disequilibrium in the short run to equilibrium in the long run. The study has also used generalised impulse response functions to check the robustness of our cointegration results.

Using annual time series data from 1970 to 2018, the empirical exercise validates the presence of asymmetries in the Twin Deficit Hypothesis for the Indian economy. This study's robust findings demonstrate that the two deficits are asymmetrically related in the long run. The authors also found that exchange rate asymmetrically affects current account deficit thus validating the asymmetric J-curve phenomenon. From the causality analysis, the authors infer that there is a weak unidirectional causality running from fiscal deficit to current account deficit.

Fiscal deficit may cause current account deficit via changes in other macroeconomic variables that were not taken care of in this study. Therefore, the estimation techniques used in the present study might suffer from the issue of omitted-variable bias. Further research should include other macroeconomic variables where the twin deficit nexus is also influenced by other relevant variables. This will help in disentangling the indirect transmissions by which fiscal deficit translates into current account deficit.

The results from our econometric exercise strongly suggest that the twin deficits are asymmetrically related. From a policy perspective, the asymmetric twin deficit nexus offers strong policy implications for the development of policies that are flexible enough to respond to shifts in internal and external sector dynamics. While framing the mechanism of fiscal prudence, policymakers in emerging countries like India must take into account the regime-changing behaviour of twin deficits.

The present paper is a significant contribution to the existing body of literature by being the first study in India which has analysed the Twin Deficits phenomenon in a nonlinear framework with the incorporation of asymmetric exchange rate dynamics in the model.

This paper aims to scrutinize the asymmetric interactions between current account deficit and gross fiscal deficit in case of a growing and dynamically integrated economy, namely, India featured with high inequality and liquidity constraints. Two additional variables, trade-openness and output growth, are also incorporated into the analysis to assess their likely impact on the current account balance.

The study uses a recently developed non-linear autoregressive distributed lag model given by Shin et al. (2014) in its empirical examination. In addition, non-linear cumulative dynamic multipliers are used to understand the route between disequilibrium position of short-run and subsequent long-run equilibrium of the system.

The study confirms the long-run co-movements of current account deficit and gross fiscal deficit and therefore refutes the Ricardian Equivalence proposition and validates the twin-deficit hypothesis. But instead of a linear relationship of the kind examined in the previous studies, the two variables share asymmetric linkages – both in the short run and in the long run. The asymmetry indicates that positive changes are more influential than their negative counterparts in the short run, whereas in the long run, only the positive changes are found to alter the external balance statistically. The asymmetric impact of fiscal deficits on the current account balance of a country may arise due to its asymmetric impact on aggregate demand through consumption inflexibility (ratchet effect) and the existence of liquidity constraints. The other control variables used in the study are also found to have cointegration with the current account deficit, but the relationship is symmetrical in the long run, even though it is asymmetrical in the short run. The study finally uses the asymmetric cumulative dynamic multipliers to examine the route of asymmetries and adjustments over the course of time. The dynamic multipliers also confirm the results documented in the earlier part and therefore demonstrate their robustness.

The asymmetric results obtained in the study provide strong grounds to devise the policies adaptive to changing arenas in domestic and external sectors. Output growth, export promotion and import substitution, increasing integration and fiscal austerity are seen as helpful in achieving a desired (and growth conducive) external balance together with macroeconomic stability. The need for a prudent fiscal policy and avoidance of profligacy is indicated based on the asymmetric results to ward off any unfavorable impact of fiscal deficits on external account. To conduct a sound fiscal policy, the government needs to cut down unproductive consumption expenditure, raise tax revenues and should pay attention to distribution and trickle-down effects to avoid the adversity of high inequality and liquidity constraints in the economy. Moreover, to ameliorate the current account balance, policies aimed at increasing the real competitiveness through control of domestic price fluctuations and improvement in the quality of tradable goods and services (such as productive investments and technological advancements) should be adopted.

Work reported in the present paper is motivated by the fact that there is no study conducted so far in the Indian context which has analyzed the two deficits in a nonlinear framework. The authors have used a well-articulated nonlinear asymmetric technique to examine the relationship between two deficits when asymmetry is incorporated. This paper will, therefore, enrich the existing literature along the lines of asymmetric linkages. Moreover, the traverse of asymmetries and adjustments over the course of time highlights the inherent dynamism of the relationship.

The essence of the modern asset‐market approach to the analysis of exchange rate behavior includes the role of the trade balance account. We examine the relationship between exchange rate changes and US trade balance announcements. Statistically significant exchange rate adjustments to these announcements are documented using for the first time the comparison period approach to testing the significance of trade balance announcements on exchange rates. The evidence is consistent with the predictions of the modern asset‐market exchange rate model. There is also evidence that the foreign exchange market is more sensitive to increasing rather than decreasing trade balance deficit announcements. To date, a number of theoretical papers have investigated the possible sources of the exchange rate determination process (see, Dornbusch [1976,1980], Dornbusch and Fisher [1980], Frenkel [1976, 1981], Kouri [1976], and Mussa [1982], among others). There is no consensus on how exchange rates are determined and why they have exhibited increased volatility lately. The interpretations vary widely among the various theories, ranging from the flow‐market approach to the modern asset‐market view. The asset‐market approach of exchange rates is based on the principle that the current value of the exchange rate (i.e. the relative price of two national currencies) is influenced not only by current economic conditions but also by expectations of its future value and, therefore, by the information that underlies these expectations. The asset‐market literature on the determination of exchange rates establishes a direct relationship between changes in the exchange rate and the current account (or trade balance account). For example, Mussa [1982] shows that the equilibrium exchange rate depends on expectations about the exogenous factors that affect the current account in present and future periods. A central implication of the asset‐market view is that “innovations” in the current account induce unexpected changes in the exchange rate. This is because an innovation in the current account, defined as a deviation of the current account balance from its previously expected level, conveys information about changes in economic conditions relevant for determining the equilibrium exchange rate (see Mussa [1982]). For example, if a country experiences an unexpectedly strong trade balance performance, this might be perceived to imply changes in relative economic efficiency, product demand, or international competitiveness that will improve the current account in future periods leading to an appreciation of the foreign value of the domestic currency. In essence, the asset‐market view argues that information about changes in real economic conditions requiring exchange rate adjustments can be inferred from innovations in the trade balance and/or the current account. Dornbusch and Fischer [1980] also argue that while asset markets determine exchange rates, it is the current account through its effect on net asset positions, and subsequently on asset markets, which influences the path of the foreign exchange rate. Thus, it can be argued that unanticipated current account announcements should be associated with exchange rate movements immediately following such announcements. While the relationship between the current account and the exchange rate has been extensively analyzed, the empirical evidence pertaining to the association between exchange rates and the current account has produced mixed results. Hardouvelis [1988] examines the effects of macroeconomic news, including US trade balance announcements, on three interest rates and seven exchange rates over the October 1979 to August 1984 period. He reports that announcements of the trade deficit have no statistically significant effects on interest rates, with the exception of the three‐month T‐bill rates and the exchange rates. The evidence with respect to the short‐term interest rate reactions may be associated with the fact that the “Federal Reserve Bank throughout the 1977–1984 period was unable to establish full credibility among market participants about its fight against inflation” (see Hardouvelis [1988]). Deravi et al [1988] have also investigated the financial market's response to US balance of trade announcements. They find similar results to those reported in Hardouvelis [1988] for the February 1980 to February 1985 period, but they report a significant exchange rate response to trade deficit announcements over the March 1985 to July 1987 period. Irwin [1989], however, uncovered a significant breakdown in the relationship between trade balance announcements and dollar exchange rates during the month of June 1984; that is, larger trade deficits were found to be associated with the dollar's depreciations only in the post‐June 1984 period. Contrary to previous studies, Hogan et al [1991] find larger US trade balance deficits to have a significant effect on exchange rates throughout the 1980s. Because expected trade balance figures are available from the Money Market Service Inc. and since the trade balance figures according to Crystal and Wood [1980] represent 85 percent of the US current account, it apears that the trade balance serves as a good proxy for the current account. Therefore, we are able to test more directly the impact of the US trade balance announcements on the exchange rate. The purpose of this paper is to analyze the relationship between exchange rate changes and merchandise balance announcements using a sample of US trade figures spanning the period from August 1986 to April 1989. In the following, we refer to this relationship as the “current account hypothesis”. Unlike previous research, the analysis is based on unanticipated trade balance announcements in order to study the interaction between exchange rates and information contained in the trade balance announced figures as the asset‐market approach to exchange rate determination process predicts. Dornbusch [1980] used the official forecast errors of the Organization for Economic Co‐operation and Development (i.e. biannual six‐month forecasts for current account and exchange rates). In this study, we focus on the major component of the current account‐the trade balance‐to test the current account hypothesis. The trade balance account is by far the best proxy for the current account. Another differentiating aspect of this study from the previous research is that it relies on systematic trade balance announcements. The use of the Commerce Departments' announcements concerning the US merchandise trade balance has also been motivated by the growing financial and non‐financial press coverage of the monthly trade balance reports. Examples of how the financial press covers the monthly trade balance announcements include: 1. “A wider trade deficit jolts a fragile market, shares off 101 points, dollar falls, and interest rates surge as big gap surprises investors, central bankers”, The Wall Street Journal, April 5,1988. 2. “London stocks rise sharply on US trade news; shares close firmer in Tokyo for the second day”, The Wall Street Journal, May 18,1989. 3. “Tricks of the Trade. The huge current‐account imbalances of the 1980s are disappearing fast. Good news? Maybe. But be warned: trade flows are less and less useful as indicators of economic performance” The Economist, March 30, 1991. 4. “Trade deficit grew in April to $6.97 billion… as exports continued to drop and imports jumped. The April deficit was the biggest monthly imbalance since a $9.49 billion deficit in November 1990. The trade gap in March was $5.58 billion. Economists say sluggish economic activity abroad is making it more difficult for US companies to sell their goods.” The Wall Street Journal, June 19, 1992. The different views registered in the financial press about the importance of the current account and trade balance imbalances in influencing exchange rate changes have further motivated the present study. Contrary to the current account hypothesis, it has been argued that because of the increasing integration of world capital markets, it is easier to finance current account deficits and therefore the trade balance or current account figures might be less useful as far as the determination of exchange rates is concerned. In addition, as a result of the increasing foreign investment activity, trade deficits may no longer represent purely national concepts. For example, a significant portion of a country's exports and imports may be accounted for by foreign firms with corporate operations there. Furthermore, US firms may decide to supply an overseas market either by exporting or by locating production abroad. Locally produced sales by US firms overseas, however, do not count as exports, nor do their local purchases of inputs count as imports. But from the firm's point of view, the local sales of a US subsidiary are viewed as being similar to exports. Therefore, it is argued that US trade balance deficits measured on the basis of residency rather than nationality of ownership, which is currently the norm, may mean less than it once did. Consequently, what emerges from the above is that the correlation between exchange rates and the information contained in the trade balance figures may be weaker than predicted by the asset‐market approach. Whether the current account or trade balance figures do matter as far as the determination of exchange rates is concerned is an empirical question. This article presents a first attempt at analyzing the impact of “innovations” in the US trade balance account on the exchange rate. An event study analysis is performed for the first time using trade balance announcement data from August 1986 to April 1989. The event methodology provides an appropriate direct test for the asset‐market model which predicts that unexpected changes in the exchange rate should be related to innovations in the current account (trade balance). The article is arranged as follows. Section II describes the data and methodology used. Section III presents empirical evidence on the relationship between exchange rates and innovations in the trade balance account. The article concludes with Section IV.

This study attempts to examine the twin deficits hypothesis for Bangladesh. Along with the traditional twin deficits hypothesis associated with the current account and fiscal deficit, the paper also explores the causal relationship between the trade deficit and fiscal deficit.

We start with the investigation of the conventional twin deficit hypothesis employing autoregressive distributed lag (ARDL) bounds testing approach in a multivariate framework. Due to the absence of cointegration between the budget deficit and trade deficit, the study adopts a multivariate vector autoregressive (VAR) model to analyze the nexus.

The study supports the presence of the twin deficits hypothesis in Bangladesh, both in the short run and long run. Unidirectional causation running from the budget deficit to the current account deficit in the long run. The trade model also supports the twin deficit hypothesis, like the aforementioned current account model.

Therefore, the sustainable fiscal deficit is the key to maintain a stable current account deficit and trade deficit in Bangladesh.

The study incorporates the country risk indicators to address the governance issue while analyzing the models' deficit scenarios because good governance is an integral part of explaining the development outcome and failure of a country like Bangladesh.

Following the 1991 crisis, India undertook reforms that liberalized trade and investment. India faced current account deficits for most of the period following these reforms. This paper analyzes sustainability of India's current account position over the last decade using the intertemporal solvency model of Hakkio and Rush and Husted. In this theoretical framework, the intertemporal solvency constraint is satisfied if there is cointegration between inflows and outflows of the current account. This paper finds cointegration between the series when allowing for a structural break using the Gregory and Hansen procedure. Dynamic generalized least squares (GLS) estimation shows a strong relation between India's current account inflows and outflows. On the basis of the empirical results, this paper concludes that there has been an improvement in trade patterns and despite experiencing deficits, India's current account position is sustainable.

The purpose of this paper is to examine the issue of high current account deficit (CAD) from various perspectives focussing its behaviour, financing pattern and sustainability for India.

To begin with the trends, composition and dynamics of CAD for India are analysed. Next, the influence of capital flows on current account is investigated using Granger non-causality test proposed by Toda and Yamamoto (1995) between current account balance (CAB) to GDP ratio and financial account balance to GDP ratio. Also, the sustainability of India’s current account is examined using different econometrics techniques. In particular, Husted’s (1992), Johansen’s cointegration and vector error correction model (VECM) is applied along with conducting unit root and structural break tests wherever applicable. Further, long-run and short-run determinants of the CAB are estimated using Johansen’s VECM.

The study found that the widening of CAD is due to fall in household financial savings and corporate investments. Also, it was found that a large part of India’s CAD has been financed by FDI and portfolio investments which are partly replaced by short-term volatile flows. The unit root and cointegration tests indicate a sustainable current account for India. Further, econometric analysis reveals that India’s current account is driven by fiscal deficit, terms of trade growth, inflation, real deposit rate, trade openness, relative income growth and the age dependency factor.

Since India’s CAD has widened and is expected to widen primarily due to rise in gold and oil imports, policy makers should focus on achieving phenomenal export growth so that a sustainable current account is maintained. Also, with rising working-age and skilled population, India should focus more on high-value product exports rather than low-value manufactured items. Further, on the structural side it is important to correct fiscal deficit as it is one of the important factors contributing to large CAD.

The paper is an important empirical contribution towards explaining India’s CAD over time using latest and comprehensive data and econometric models.

Deficits in fiscal and current account balances in a large number of countries reveal interesting implications of the causal relationship between internal and external imbalances. Empirical evidence about the occurrence of so-called twin deficits or twin surpluses provides crucial information about the validity of an intertemporal approach. However, most recent dynamic cyclical changes during the crisis period revealed many questions about the direct interconnection between macroeconomic performance and twin imbalances. In the paper we observe substantial features of twin imbalances in European transition economies. Event study (identification of large fiscal and current account changes and their parallel occurrence) and vector auto-regression methods will be employed to examine key aspects of twin imbalances. Our results suggest that current account deteriorations were predominately associated with negative public investment and savings balances (fiscal deficits), while current account improvements were predominately associated with positive private investment and savings balances, confirming empirical evidence about twin deficits in European transition economies.