Abstract

The twin deficits hypothesis mainly states that government budget deficits will cause a trade or current account deficit, which implies that government budget deficits have a negative impact on the current or trade account balance. However; this is not the only theoretically possible relationship between budget deficits and the trade or current account. On the other hand, if the Ricardian equivalence hypothesis holds it is also possible that the budget deficit has no impact on the current account. This study assesses the impact of the fiscal deficit on the current account balance. In this study, two hypotheses about the relationship between the budget deficit and the current account balance for East Africa between 1980-2003 are examined to variables from the theoretical model that include GDP growth rate, Real exchange rate, terms of trade and the budget deficit and also incorporates a dummy variable for the structural adjustment policies among the variables and also tested for the influence of individual country differences on the current account balance. Panel data estimation techniques were applied in the analysis of the hypotheses we found support for the twin deficits hypothesis in East Africa, given that the fiscal deficit has a significant negative impact on the current account balance. Therefore it can be concluded that the Ricardian equivalence hypothesis does not hold in the case of East Africa. Terms of trade and the dummy variable for structural adjustment were found to have significant negative impact on the current account balance while GDP growth rate was found to have a significant positive impact while the real exchange rate has an insignificant impact on the current account balance in East Africa.

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School	: School of Law, Economics and Government
Issued Date	: 2007

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