Testing the Twin Deficit Hypothesis for Kenya 1970-2012

Abstract

The Twin Deficit Hypothesis (TDH) is an economic proposition suggesting that there exists a positive causal association between Budget deficit and Current account deficit. This assertion has been the subject of debate in the scholarly and policy front. However, most of the already existing literature on the TDH has focused on already developed economies. Majority of this literature carried out bivariate analysis using annual data. This study investigates the TDH nexus for Kenya using quarterly data spanning from 1970Q 1-2012Q 1 in a multivariate approach. The study employed various econometric tests including Johansen & Juselius cointergration tests, Vector Auto Regression and Toda-Yamamoto's Granger causality test. The study also estimated the Impulse response functions and Variance decomposition. The results indicate that the TDH does exist in Kenya in a multivariate environment as opposed to directly between budget deficits and current account deficits. The study proposes that the government should formulate adequate fiscal and monetary policies that will effectively manage the country expenditure and revenue. The government should also look into ways of increasing its revenues and reducing expenditures.