Twin Deficit Hypothesis: Case of Kyrgyzstan

Abstract

The study analyzes the relationship between budget deficit and trade deficit in the Kyrgyz Republic as the economy of the country is experiencing both the state budget and current account imbalance for a long period since the country became independent. The analytical approach to study this phenomenon is called the twin deficit hypothesis. The topic became popular starting from the 1980s as the US economy suffered from both fiscal and trade deficits due to expansionary tax policies. There are two kinds of thoughts put forward by researchers, where proponents of the twin deficit hypothesis state that there is a causal relationship between budget and trade deficit and budget deficit causes trade deficit. However, opponents of the theory emphasize that there is no correlation between the two deficits. Thus, by applying the VAR model as well as the Granger Causality test and IRFs for the time horizon 1995q1-2020q4 we have checked for the relationship of two deficits. The results of our analysis show that the budget deficit does not cause the trade deficit in the short-run. However, there is a significantly negative relationship between remittances inflow and the trade balance of the country.