The twin deficit hypothesis: the case of Bulgaria

Abstract

Recent developments in the Bulgarian economy bring into question the validity of the twin deficit hypothesis. This paper analyses the theoretical foundations of and alternative explanations for this hypothesis and uses different econometric approaches to test its validity on a sample of the Bulgarian data. A Granger causality test suggests the existence of dual causality between the fiscal and current account deficits. A vector autoregressive and a vector error correction model both reject the twin deficit hypothesis in the short run, but indicate that it might be valid in the long run.

Keywords

• current account targeting
• twin deficit hypothesis
• Granger causality
• vector autoregressive analysis
• vector error correction