The twin deficits hypothesis: Revisiting an EMU country

Abstract

We re-examine the issue of the twin deficits hypothesis since recent theoretical and empirical analysis suggests that this hypothesis is subject to structural shifts, the identification of which is very important for policymakers in order to take the correct decisions to overcome situations of economic turmoil. We utilise a different empirical approach and we extend the data sets. We use a multivariate Vector Error Correction framework including the endogenous determination of structural breaks, to determine the causal relation between the budget deficit and the current account deficit for Greece. The two deficits are found to be positively linked through the Current Account Targeting Hypothesis. © 2011 Society for Policy Modeling.