The twin deficits hypothesis in developing countries: Empirical evidence for Ghana

The importance of fiscal discipline and having a current account close to equilibrium for macroeconomic stability and sustained economic growth of countries is unquestionable. Persistent fiscal and current account deficits, if unattended, could extend beyond one country (or region) and lead to global financial instability and possibly an economic crisis with dire repercussions for future generations.

While Ghana has been engulfed in fiscal deficits due to massive borrowing by the government both domestically and abroad, the increasing current account deficit has often been attributed to the higher than expected oil import bill and the depreciation of the Ghanaian cedi against its trading currencies.

The issue of whether there exists a long-run relationship between fiscal and current account deficits follow the tenets of the: (i) twin deficits hypothesis (i.e., an increase in fiscal deficit worsens the current account deficit), (ii) Ricardian equivalence (i.e., an increase in fiscal deficit has no effect on the current account deficit), and (iii) twin divergence hypothesis (i.e., an increase in fiscal deficit improves the current account deficit) has in recent years become debatable both in the developed and, mainly the developing countries.

This project tries to contribute to this ongoing debate by investigating whether there exist a long-run relationship between Ghana’s fiscal and current account deficits.

In considering this topic for Ghana, the very likely research questions that emanate are:

  1. How has Ghana’s fiscal deficit contributed to its current account deficit?
  2. What are the implications of such a relationship, if any or otherwise, for macroeconomic stability and sustained economic growth?

Through empirical investigation, researchers examined whether the (i) twin deficits hypothesis, (ii) Ricardian equivalence, or (iii) twin divergence hypothesis hold for Ghana.

The findings of the project will provide important policy implications that the Ministry of Finance and Economic Planning, the Ministry of Trade and Industry, and the Bank of Ghana may consider in their policy reforms.

 

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