An Econometric Analysis of the Twin Deficits Hypothesis in Greece During the Period 1960 – 2014

Abstract

The relationship between budget and trade deficits attracted the interest of many scholars during the last two decades. Many economists linked the large fiscal deficits and public debt with the trade imbalances. In this paper, we apply annual data in order to investigate the twin deficits hypothesis in a small open economy like Greece during the last 6 decades, which has faced many problems with public debt and deficits. We deploy cointegration techniques, as well as, the Granger causality tests in order to identify the direction of causality between the two forms of the deficits. We find that there is a long run relationship between the two variables, while the causality is running from the budget to the current account deficit, which provides support to the twin deficits hypothesis. This is in accordance with the Mundell-Fleming theory which suggests that there should be a causal relationship between the budget and the trade deficit, and moreover, this causality runs primarily from fiscal deficits to the current account deficits.