The Relationship between Current Account and Government Budget Balance: The Case of Kuwait

Abstract

The aim of this study is to examine the twin deficits hypothesis for Kuwait for the quarterly period (1993:4 2010:4). The twin deficit hypothesis states that an increase in the budget deficit will cause a similar increase in current account deficit. To analyze the relationship between the two variables, the paper tests the stationarity of the two variables, estimates the cointegration regression (the Johansen cointegration test), applies the VAR model, estimates the IRF, and tests for existence and the direction of causality. The causality test shows that the direction of causality goes from current account to budget balance. The other direction was not confirmed for this study. In addition, the results of this paper find a negative long-run relationship between current account and budget balance that is an increase in current account causes a decrease in the government budget surplus or an increase in budget deficit. This finding fits the Kuwaiti economy; since an improvement in the current account driven primarily by the improvement in the trade balance will cause the central government to spend more than it receive in revenue causing a decrease in government budget surplus or an increase in government budget deficit. Therefore, this paper reached to a conclusion that the twin deficit hypothesis was not confirmed for the Kuwaiti case.

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