Justification of the twin deficit hypothesis in Bangladesh

Abstract

Purpose – In light of Bangladesh’s economy, the goal of this study is to examine the “Twin Deficit Hypothesis (TDH),” which refers to a link between the budget deficit and the current account deficit. This study used yearly time series data from 1980 to 2020 to investigate the phenomena. Design/methodology/approach – A multivariate autoregressive distributive lag (ARDL) model has been presented for empirical investigation, with the ARDL bound test investigating the co-integration between the inadequacies. As some of the variables in the bound test lack co-integration, the study adds a multivariate vector autoregressive (VAR) model later on. Findings – With evidence of the result, the study supports the validation of twin deficit hypothesis in Bangladesh economy since both current account deficit and fiscal deficit affects each other significantly whereas Granger causality test confirms that fiscal deficit causes current account deficit but not the other way around. Practical implications – The government should maintain a restrictive monetary policy in order to stabilize the current account deficit. Originality/value – The novelty of this study is the incorporation of inflation, real exchange rate and GDP per capital to TDH that together form the basis for a macroeconomic snapshot of the economy.

Keywords

• ARDL
• Bangladesh
• Budget deficit
• Current account deficit
• Granger-causality test