The twin deficits hypothesis and reverse causality: A short-run analysis of Peru


  • César R. Sobrino School of Business & Entrepreneurship, Universidad del Turabo, Gurabo, Puerto Rico


Current Account, Time Series Models, Budget Deficit


This study examines causation between the current account and the fiscal surplus and fiscal spending for a commodity-based economy, Peru. Using quarterly data for the open economy, the outcomes reject the twin deficits hypothesis. Instead, the evidence points strongly to reverse causality, that is, the current account causes the fiscal account. However, unlike previous empirical evidence on this subject, for a year, the reverse causality indicates a negative causation because the fiscal consumption is not smoothed when positive permanent shocks to the current account occur. In the short run, the fiscal policy has no effect on the current account, but improvements in the current account increase the probability of attaining a lower bounded fiscal deficit. This evidence is consistent with a small open commodity-based economy that is highly exposed and sensitive to external price shocks.

DOI: 10.1016/S2077-1886(13)70018-0


Download data is not yet available.


Alkswani, M.A., 2000. The twin deficits phenomenon in petroleum economy: Evidence from Saudi Arabia. Paper presented in Seventh Annual Conference, Economic Research Forum (ERF), 26-29 October, Amman, Jordan.

Anoruo, A., Ramchander, S., 1998. Current account and fiscal deficits: Evidence from five developing economies of Asia. Journal of Asian Economics 9 (3), 487-501.

Arize, A.C., Malindretos, J., 2008. Dynamics linkages and granger causality test between trade and budget deficits: Evidence from Africa. African Journal of Accounting, Economics, Finance and Banking Research 2 (2), 1-19.

Bacham, D.D., 1992. Why is the US current account deficit so large? Evidence from vector autogressions. Southern Economic Journal, 59(2), 232-240.

Baharumshah, A. Z., Lau, E., Khalid, A.M., 2006. Testing twin deficits hypothesis using VARs and variance decomposition. Journal of the Asia Pacific Economy 11 (3), 331-354.

Bartolini, L., Lahiri, A., 2006. Twin deficits: Twenty years later. Federal Reserve Bank of New York, Current Issues in Economics and Finance 12 (7).

Bussière, M., Fratzscher, M., Müller, G.J., 2005. Productivity shocks, budget deficits and the current account. European Central Bank, Working Paper Series # 509.

Castillo, P., Barco, D., 2008. Facing up a sudden stop of capital flows: Policy lessons from the 90’s Peruvian experience. Central Reserve Bank of Peru Working Papers #2008-002.

Chinn, M.D., Prasad, E.S., 2003. Medium-Term determinants of current accounts in industrial and developing countries: An empirical exploration. Journal of International Economics 59 (1), 47-76.

Chinn, M.D., Ito, H., 2007. Current account balances, financial development and institutions: Assaying the world “saving glut.” Journal of International Money and Finance 26 (4), 546-569.

Corsetti, G., Müller, G.J., 2006. Twin deficits: Squaring theory, evidence and common sense. Economic Policy 21 (48), 597-638.

Darrat, A.F., 1988. Have large budget deficits caused rising trade deficits? Southern Economic Journal 54 (4), 879-886.

Enders, W., Lee, B.S., 1990. Current account and budget deficits: Twins or distant cousins? The Review of Economics and Statistics 72 (3), 373-381.

Erceg, C.J., Guerrieri, L., Gust, C., 2005. Expansionary fiscal shocks and the US trade deficit. International Finance 8 (3), 363-397.

Fleegler, E., 2006. The twin deficits revisited: A cross-country, empirical approach. Duke University, Mimeo, Durham, NC.

Garcia-Escribano, M., 2010. Peru: Drivers of de-dollarization. International Monetary Fund, Working paper, 10/169.

Hatemi, A., Shukur, G., 2002. Multivariate-Based causality tests of twin deficits in the US. Journal of Applied Statistics 29 (6), 817-824.

Hutchinson. M.M., Pigott, C., 1984. Budget deficits, exchange rate and current account: Theory and U.S evidence. Federal Reserve of Bank of San Francisco, Economic Review 4, 5-25.

Islam, M.F., 1998. Brazil’s twin deficits: An empirical examination. Atlantic Economic Journal 26 (2), 121-128.

Jayaraman, T.K., Choong, C.K., 2007. Do fiscal deficits cause current account deficits in the Pacific island countries? A case study of Fiji. University of South Pacific, Working Paper #8.

Khalid, A.M., Teo, W.G., 1999. Causality tests of budget and current account deficits: Cross-country comparisons. Empirical Economics 24, 389-402.

Kim, C.H., Kim, D., 2006. Does Korea have twin deficits? Applied Economics Letters 13 (10), 675-680.

Kim, S., Roubini, N., 2008. Twin Deficit or Twin Divergence? Fiscal policy, current account, and real exchange rate in the US. Journal of International Economics 74 (2), 362-383.

Kouassi, E., Mougoué M., Kymn, K.O., 2004. Causality tests of the relationship between the twin deficits, empirical economics 29 (3), 503-525.

Lau, E., Baharumshah, A.Z., 2004. On the twin deficits hypothesis: Is Malaysia different? Pertanika Journal of Social Sciences and Humanities 12 (2), 87-100.




How to Cite

Sobrino, C. R. . (2013). The twin deficits hypothesis and reverse causality: A short-run analysis of Peru. Journal of Economics, Finance and Administrative Science, 18(34), 9–15. Retrieved from