Consolidation first - About twin deficits and the causal relation between fiscal budget and current account imbalances

During recent years, large trade- and budget deficits have accumulated especially in advanced economies. This study examines if this coincidence actually reflects a causal relation. Economic theory and previously documented findings on causality between trade and government balances are inconclusive. Summarizing evidence over a cross section of 19 advanced economies, we document that the budget balance influences the current account in a more pronounced way than vice versa. Moreover, the documented causal influence is characterized by a stronger tendency towards a twin deficit (or -surplus) rather than a twin divergence.