Z.Asli Alici, Ph.D, International Finance, Yeditepe University, Faculty of Commerce, Kayisdagi Cad. 26 Agustos Yerlesimi; Kadiköy, Istanbul, 34755, Turkey
The relationship between “high” government budget and “high” current account deficits have been explored in several studies by the so-called name “twin deficits”. Conventional Keynesian twin deficits proposition mainly states that an increase in government budget deficit leads to an increase in the current account deficit. But it is also possible if Ricardian equivalence hypothesis is valid the two deficits may not be related at all.
In the last two decades despite all stabilization efforts, Turkish economy continued to run high budget deficits hand in hand with trade deficits. The persistent and coinciding fiscal and external trade deficits in Turkey have been in the economic spotlight largely because of its important policy implications for the long-term economic progress. The aim of this study is to examine whether higher budget deficits lead to greater current account deficits in Turkey between 1987 - 2006. This paper uses the autoregressive distributed lag (ARDL) model and the bounds test for cointegration (Pesaran et al. 2001) to assess the dynamics between the twin deficits in Turkey. The model used in the study enables to search the relationship between the internal and external deficits both in the short-run and in the long-run by indicating the direction of causality between the two deficits.
JEL Classification: F11
Keywords: Twin Deficits, Ricardian Equivalence Hypothesis, Cointegration, Error-Correction Model, Granger-causality, Turkey.