Twin deficits hypothesis in Bangladesh: an empirical investigation

Abstract

Purpose 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. Design/methodology/approach 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. Findings 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. Practical implications Therefore, the sustainable fiscal deficit is the key to maintain a stable current account deficit and trade deficit in Bangladesh. Originality/value 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.

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