Twin Deficits: An Alternative Framework from General Equilibrium Perspective with U.S. Results

This study proposes an alternative theoretical framework for testing twin deficits hypothesis from the general equilibrium perspective (income-expenditure equilibrium) that takes both the behavioural variables - saving and investment into consideration. Empirically, the cointegration tests show U.S. fiscal balance, current account balance, real GDP and interest rates (short- and long-run) are co-moved over the periods 1970Q2 - 2011Q4. The real income and interest rates from the saving and investment channels, are important variables in explaining the U.S. current account deficit. The empirical results validate the twin deficits hypothesis in U.S. Some policy implications have been drawn – “fiscal cliffâ€. This study also suggests the profolio balance approach from the general equilibrium perspective for future twin deficits analysis.