An Empirical Investigation of the Twin Deficit Hypothesis: Evidence from Sri Lanka
Economic Research Department of Central Bank of Sri Lanka, LK
Mr. Anil Perera is an Economist attached to the Economic Research Department of Central Bank of Sri Lanka. He received a BA Special Degree in Economics with First Class Honours from University of Sri Jayewardenepura, Sri Lanka and Master of Social Sciences Degree in Economics from University of Kelaniya, Sri Lanka. Currently, he is reading for a doctoral degree at Monash University, Australia. His research interests are in the fields of monetary policy, financial markets and macroeconomic management.
Economic Research Department of the Central Bank of Sri Lanka, LK
Ms. Erandi Liyanage is a Senior Economist attached to the Economic Research Department of the Central Bank of Sri Lanka. She received a BA Special Degree in Economics from the University of Colombo, Sri Lanka and Master of Economics from the same university. She also obtained a Master of Economics degree from the University of Sydney, Australia. Her research interests are in the fields of fiscal policy, international trade and macroeconomic management.
Theoretical and empirical evidence proves that prolonged fiscal expansions contribute to current account imbalances and hence, there exists a positive-long run relationship between budget deficits and current account deficits. This relationship is referred to as ‘twin deficit hypothesis.’ Significant fiscal expansions and external imbalances, which caused macroeconomic instability in a large number of advanced countries and emerging countries, have motivated examining the issue of twin deficits. Like many other emerging countries, for a long period of time, Sri Lankan economy has been experiencing persistently high budget deficits and current account deficits. In this study, we attempt to explore the twin deficit hypothesis interacting with key financial variables using both annual and quarterly data for Sri Lanka and employing multivariate empirical methodology. We find evidence for long run relationships between twin deficits in Sri Lanka. At the same time, we detect unidirectional causation between twin deficits, which enables into draw several policy implications.
How to Cite:
Perera, A. and Liyanage, E., 2012. An Empirical Investigation of the Twin Deficit Hypothesis: Evidence from Sri Lanka. Staff Studies, 41(1), pp.41–87. DOI: http://doi.org/10.4038/ss.v41i1.4683