Testing Relevance of Twin Deficit for a Transition Economy Like Pakistan

Muhammad Shahid HASSAN, Ayesha WAJID, Haider MAHMOOD, Muhammad SHAHBAZ

Abstract


The relationship between trade defi cit and fi scal defi cit has remained an important topic in the last decades. The literature reveals many attempts to investigate the relationship between the two defi cits, while terminologies like Keynesian Proposition, Ricardian Equivalence, and Targeting Current Account Defi cit are used for the relationship between the two defi cits. The literature also highlights the possibility of unidirectional or bidirectional causality between these defi cits for different countries and different time spans. These four possibilities have inspired us to investigate these possibilities in the light of many control variables like unemployment, urbanization, money supply, foreign direct investment, and economic development in the case of Pakistan. The fi ndings of the study reveal that fi scal defi cit signifi cantly accelerates trade defi cit into both long term and short term; hence, it supports the Keynesian Proposition in Pakistan, while a bidirectional causality between fi scal defi cit and trade defi cit into both long term and short term was also observed. Moreover, the mean and variance of error term were also found to be structurally stable which confi rms the absence of structural break for the selected period in Pakistan. In the end, based on these fi ndings, this study has concluded that two possibilities prevail out of four on the relationship between fi scal and trade defi cits. The twin defi cit is relevant and it does prevail in a transition economy like Pakistan.


Keywords


Pakistan, fi scal and trade defi cit (twin defi cit), causality, cointegration.

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