Does the Twin-Deficits doctrine apply to the Gulf Cooperation Council? A dynamic panel VAR-X model approach

AL-JAHWARI, SALIM AHMED SAID (2021): Does the Twin-Deficits doctrine apply to the Gulf Cooperation Council? A dynamic panel VAR-X model approach.

Abstract

Economies around the world tend to show a strong link from fiscal to current accounts deficits. The phenomenon is recognized as the twin-deficits doctrine, which stipulates the presence of a uni-directional causal relationship from the fiscal account deficit (FD) to the current account deficit (CD). This relationship is also apparent for the commodity-based economies of the Gulf Cooperation Council States (GCC). The region is well-documented to rapidly succumb to deteriorating fiscal and current account deficits with any prolonged decline in international crude oil prices. This study extends the research of Granger non-causality between budget deficits by employing a macro-panel in a two-dimensional vector autoregression model with an exogenous variable (VAR-X) process where oil is included as the exogenous control variable. The study uses a homogeneous model in the generalized method of moments framework to conduct a comprehensive investigation between the two deficits and analyze if the twin-deficits doctrine applies to the GCC. A heterogeneous model with fixed time coefficients is then used as a robustness check to assess if the twin-deficits phenomenon applies to any of the GCC States. The results indicate that the pooling of data from six GCC States and the inclusion of international oil prices, as the third latent element, leads to the dismissal of the twin-deficits doctrine for the GCC as an integrated unit of analysis, and, for each member State of the GCC individually. Interestingly, the analysis uncovers a reverse direction of causality running from CD to FD.

• Item Type: MPRA Paper
• Language: English
• Keywords: Twin-Deficits; Granger non-causality; Gulf Cooperation Council; Macro-panels; VAR-X.
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C23 - Panel Data Models ; Spatio-temporal Models; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; F - International Economics > F3 - International Finance > F32 - Current Account Adjustment ; Short-Term Capital Movements; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics

References

Abell, J. D. (1990). Twin deficits during the 1980s: An empirical investigation. Journal of Macroeconomics, 12(1), 81–96. https://doi.org/10.1016/0164-0704(90)90057-H

Abrigo, M. R. M., & Love, I. (2016). Estimation of Panel Vector Autoregression in Stata. The Stata Journal, 16(3), 778–804. https://doi.org/10.1177/1536867X1601600314

Ahn, S. C., & Schmidt, P. (1995). Efficient estimation of models for dynamic panel data. Journal of Econometrics, 68(1), 5–27. https://doi.org/10.1016/0304-4076(94)01641-C

Akanbi, O. A., & Sbia, R. (2018). Investigating the twin-deficit phenomenon among oil-exporting countries: Does oil really matter? Empirical Economics, 55(3), 1045–1064. https://doi.org/10.1007/s00181-017-1336-0

Al Khalifa, L. (2015). THE TWIN DEFICITS HYPOTHESIS IN AN OIL BASED ECONOMY: THE CASE OF BAHRAIN. International Journal of Economics, Commerce and Management, 3(1), 13.

Alexander, S. S. (1952). Effects of a Devaluation on a Trade Balance. Staff Papers - International Monetary Fund, 2(2), 263. https://doi.org/10.2307/3866218

Alexander, S. S. (1959). Effects of a Devaluation: A Simplified Synthesis of Elasticities and Absorption Approaches. The American Economic Review, 49(1), 22–42.

Alkswani, M. A. (n.d.). The Twin Deficits Phenomenon in Petroleum Economy: 25.

Anderson, T. W., & Hsiao, C. (1982). Formulation and estimation of dynamic models using panel data. Journal of Econometrics, 18(1), 47–82. https://doi.org/10.1016/0304-4076(82)90095-1

Andrews, D. W. K., & Lu, B. (2001). Consistent model and moment selection procedures for GMM estimation with application to dynamic panel data models. Journal of Econometrics, 101(1), 123–164. https://doi.org/10.1016/S0304-4076(00)00077-4

Arellano, M., & Bond, S. (1991). Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations. The Review of Economic Studies, 58(2), 277–297. https://doi.org/10.2307/2297968

Arellano, M., & Bover, O. (1995). Another look at the instrumental variable estimation of error-components models. Journal of Econometrics, 68(1), 29–51. https://doi.org/10.1016/0304-4076(94)01642-D

Baltagi, B. H. (2005). Econometric analysis of panel data (3rd ed). J. Wiley & Sons.

Baltagi, B. H., Griffin, J. M., & Xiong, W. (2000). To Pool or Not to Pool: Homogeneous Versus Heterogeneous Estimators Applied to Cigarette Demand. Review of Economics and Statistics, 82(1), 117–126. https://doi.org/10.1162/003465300558551

Barro, R. J. (1974). Are Government Bonds Net Wealth? Journal of Political Economy, 82(6), 1095–1117. https://doi.org/10.1086/260266

Barro, R. J. (1977). Unanticipated Money Growth and Unemployment in the United States. The American Economic Review, 67(2), 101–115.

Bernheim, B. D. (1987). Ricardian Equivalence: An Evaluation of Theory and Evidence. NBER Macroeconomics Annual, 2, 263–304. https://doi.org/10.1086/ma.2.4623723

Bernheim, B. D. (1988). Budget Deficits and the Balance of Trade. Tax Policy and the Economy, 2, 1–31. https://doi.org/10.1086/tpe.2.20061771

Bernheim, B. D., & Bagwell, K. (1988). Is Everything Neutral? Journal of Political Economy, 96(2), 308–338.

Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics, 29.

Breitung, J., & Pesaran, M. H. (2005). Unit roots and cointegration in panels. Dt. Bundesbank.

Broda, C. (2001). Coping with Terms-of-Trade Shocks: Pegs versus Floats. The American Economic Review, 91(2), 376–380.

Buchanan, J. M. (1976). Barro on the Ricardian Equivalence Theorem. Journal of Political Economy, 84(2), 337–342.

Cagala, T., & Glogowsky, U. (2015). XTVAR: Stata module to compute panel vector autoregression. https://econpapers.repec.org/software/bocbocode/s457944.htm

Central Bank of Kuwait: Exchange Rate Policy. (2021). https://www.cbk.gov.kw/en/monetary-policy/exchange-rate-policy

Choi, I. (2001). Unit root tests for panel data. Journal of International Money and Finance, 20(2), 249–272. https://doi.org/10.1016/S0261-5606(00)00048-6

Das, P. (2019). Dynamic Panel Model. In P. Das (Ed.), Econometrics in Theory and Practice: Analysis of Cross Section, Time Series and Panel Data with Stata 15.1 (pp. 541–565). Springer. https://doi.org/10.1007/978-981-32-9019-8_18

Dumitrescu, E.-I., & Hurlin, C. (2012). Testing for Granger non-causality in heterogeneous panels. Economic Modelling, 29(4), 1450–1460. https://doi.org/10.1016/j.econmod.2012.02.014

Enders, W., & Lee, B.-S. (1990). Current Account and Budget Deficits: Twins or Distant Cousins? The Review of Economics and Statistics, 72(3), 373. https://doi.org/10.2307/2109344

Freudmann, A. (2010, March 1). The GCC in 2020. Perspectives from The Economist Intelligence Unit (EIU). https://eiuperspectives.economist.com/economic-development/gcc-2020-0

GCC - STAT. (2018, October). Gulf Corporation Council(GCC)with less oil income. Statistical Centre for the Cooperation Council for the Arab Countries of the Gulf. http://gccstat.org/images/gccstat/docman/publications/GCC_with_less_oil_income_3.pdf

Ghosh, A., & Ramakrishnan, U. (2020, February 24). Finance & Development. Finance & Development | F&D. https://www.imf.org/external/pubs/ft/fandd/basics/current.htm

Gnimassoun, B., Joëts, M., & Razafindrabe, T. (2017). On the link between current account and oil price fluctuations in diversified economies: The case of Canada. International Economics, 152, 63–78. https://doi.org/10.1016/j.inteco.2017.07.001

Gramlich, E. M. (2004, May 14). FRB: Speech, Gramlich—Budget and Trade Deficits: Linked, Both Worrisome in the Long Run, but not Twins—May 14, 2004. The Federal Reserve Board. https://www.federalreserve.gov/boarddocs/speeches/2004/20040225/default.htm

Granger, C. W. J. (1969). Investigating Causal Relations by Econometric Models and Cross-spectral Methods. Econometrica, 37(3), 424–438. https://doi.org/10.2307/1912791

Granger, C. W. J. (1980). Long memory relationships and the aggregation of dynamic models. Journal of Econometrics, 227–238.

Griffiths, W. E., Hill, R. C., & Judge, G. G. (1993). Learning and practicing econometrics. Wiley.

Hadri, K. (2000). Testing for stationarity in heterogeneous panel data. The Econometrics Journal, 3(2), 148–161. https://doi.org/10.1111/1368-423X.00043

Han, C., & Phillips, P. C. B. (2010). GMM ESTIMATION FOR DYNAMIC PANELS WITH FIXED EFFECTS AND STRONG INSTRUMENTS AT UNITY. Econometric Theory, 26(1), 119–151. https://doi.org/10.1017/S026646660909063X

Hansen, B. E., University of Wisconsin., & Department of Economics. (2002). Econometrics. [University of Wisconsin, Dept. of Economics]; /z-wcorg/.

Hansen, L. P. (1982). Large Sample Properties of Generalized Method of Moments Estimators. Econometrica, 50(4), 1029. https://doi.org/10.2307/1912775

Harberger, A. C. (1950). Currency Depreciation, Income, and the Balance of Trade. Journal of Political Economy, 58(1), 47–60. https://doi.org/10.1086/256897

Hashem Pesaran, M. (2003). Aggregation of linear dynamic models: An application to life-cycle consumption models under habit formation. Economic Modelling, 20(2), 383–415. https://doi.org/10.1016/S0264-9993(02)00059-7

Holtz-Eakin, D., Newey, W., & Rosen, H. S. (1988). Estimating Vector Autoregressions with Panel Data. Econometrica, 56(6), 1371–1395. https://doi.org/10.2307/1913103

Hsiao, C. (1985). Benefits and limitations of panel data. Econometric Reviews, 4(1), 121–174. https://doi.org/10.1080/07474938508800078

Hsiao, C. (1986). Analysis of panel data. Cambridge University Press.

Hurlin, C., & Mignon, V. (2007). Second Generation Panel Unit Root Tests. https://halshs.archives-ouvertes.fr/halshs-00159842

Im, K. S., Pesaran, M. H., & Shin, Y. (2003). Testing for unit roots in heterogeneous panels. Journal of Econometrics, 115(1), 53–74. https://doi.org/10.1016/S0304-4076(03)00092-7

IMF. (2015, December 10). Gulf Cooperation Council (GCC)—Tax Policy Reforms in the GCC Countries—Now and How? Policy Papers.

International Monetary Fund (Ed.). (2014). Government finance statistics manual 2014. International Monetary Fund.

Judson, R. A., & Owen, A. L. (1999). Estimating dynamic panel data models: A guide for macroeconomists. Economics Letters, 65(1), 9–15. https://doi.org/10.1016/S0165-1765(99)00130-5

Kalou, S., & Paleologou, S.-M. (2012). The twin deficits hypothesis: Revisiting an EMU country. Journal of Policy Modeling, 34(2), 230–241. https://doi.org/10.1016/j.jpolmod.2011.06.002

Kaufmann, S., Scharler, J., & Winckler, G. (2002). The Austrian current account deficit: Driven by twin deficits or by intertemporal expenditure allocation? Empirical Economics, 27(3), 529–542. https://doi.org/10.1007/s001810100094

Keynes, J. M. (1936). The general theory of employment, interest and money. London : Macmillan and Co., Limited.

Kim, C.-H., & Kim, D. (2006). Does Korea have twin deficits? Applied Economics Letters, 13(10), 675–680. https://doi.org/10.1080/13504850500404910

Kim, S., & Roubini, N. (2008). Twin deficit or twin divergence? Fiscal policy, current account, and real exchange rate in the U.S. Journal of International Economics, 74(2), 362–383. https://doi.org/10.1016/j.jinteco.2007.05.012

Kónya, L. (2006). Exports and growth: Granger causality analysis on OECD countries with a panel data approach. Economic Modelling, 23(6), 978–992. https://doi.org/10.1016/j.econmod.2006.04.008

Kouassi, E., Mougoue, M., & Kymn, K. O. (2004). Causality tests of the relationship between the twin deficits. Empirical Economics, 29(3), 503–525. https://doi.org/10.1007/s00181-003-0181-5

Kwiatkowski, D., Phillips, P. C. B., Schmidt, P., & Shin, Y. (1992). Testing the null hypothesis of stationarity against the alternative of a unit root. Journal of Econometrics, 54(1–3), 159–178. https://doi.org/10.1016/0304-4076(92)90104-Y

Laursen, S., & Metzler, L. A. (1950). Flexible Exchange Rates and the Theory of Employment. The Review of Economics and Statistics, 32(4), 281–299. https://doi.org/10.2307/1925577

Lopez, L., & Weber, S. (2017). Testing for Granger Causality in Panel Data. The Stata Journal, 17(4), 972–984. https://doi.org/10.1177/1536867X1801700412

Love, I., & Zicchino, L. (2006). Financial development and dynamic investment behavior: Evidence from panel VAR. The Quarterly Review of Economics and Finance, 46(2), 190–210. https://doi.org/10.1016/j.qref.2005.11.007

Lütkepohl, H. (1982). Non-causality due to omitted variables. Journal of Econometrics, 19(2), 367–378. https://doi.org/10.1016/0304-4076(82)90011-2

Macklem, R. T. (1993). Terms-of-Trade Disturbances and Fiscal Policy in a Small Open Economy. The Economic Journal, 103(419), 916–936. https://doi.org/10.2307/2234710

Malik, M., & Nagesh, T. (2021). Fiscal Sustainability and Hydrocarbon Endowment Per Capita in the GCC. In G. Luciani & T. Moerenhout (Eds.), When Can Oil Economies Be Deemed Sustainable? (pp. 215–253). Springer. https://doi.org/10.1007/978-981-15-5728-6_9

Marinheiro, C. F. (2008). Ricardian equivalence, twin deficits, and the Feldstein–Horioka puzzle in Egypt. Journal of Policy Modeling, 30(6), 1041–1056. https://doi.org/10.1016/j.jpolmod.2007.12.001

Merza, E., & Alawin, M. (2012). The Relationship between Current Account and Government Budget Balance: The Case of Kuwait. International Journal of Humanities and Social Science, 2(7), 10.

Mirzoev, T. N., Zhu, L., Yang, Y., Zhang, T., Roos, E., Pescatori, A., & Matsumoto, A. (2020, February 6). The Future of Oil and Fiscal Sustainability in the GCC Region. IMF. https://www.imf.org/en/Publications/Departmental-Papers-Policy-Papers/Issues/2020/01/31/The-Future-of-Oil-and-Fiscal-Sustainability-in-the-GCC-Region-48934

Nair‐Reichert, U., & Weinhold, D. (2001). Causality Tests for Cross-Country Panels: A New Look at FDI and Economic Growth in Developing Countries. Oxford Bulletin of Economics and Statistics, 63(2), 153–171. https://doi.org/10.1111/1468-0084.00214

Nickell, S. (1981). Biases in Dynamic Models with Fixed Effects. Econometrica, 49(6), 1417–1426. https://doi.org/10.2307/1911408

Pesaran, M. H. (2007). A Simple Panel Unit Root Test in the Presence of Cross-Section Dependence. Journal of Applied Econometrics, 22(2), 265–312.

Phillips, P. C. B. (2014). Dynamic Panel GMM with Near Unity. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2532991

Phillips, P. C. B., & Perron, P. (1988). Testing for a Unit Root in Time Series Regression. Biometrika, 75(2), 335–346. https://doi.org/10.2307/2336182

Romer, D. (2012). Advanced macroeconomics (4th ed). McGraw-Hill/Irwin.

Rosensweig, J. A., & Tallman, E. W. (1993). Fiscal policy and trade adjustment: Are the deficits really twins? Economic Inquiry, 31(4), 580. https://doi.org/10.1111/j.1465-7295.1993.tb00892.x

Salvatore, D. (2006). Twin deficits in the G-7 countries and global structural imbalances. Journal of Policy Modeling, 28(6), 701–712. https://doi.org/10.1016/j.jpolmod.2006.06.003

Setser, B. (2007). Oil and Global Adjustment.

Shehabi, M. (2021). Redefining Economic Sustainability in Resource-rich States: Comparative Lessons. In G. Luciani & T. Moerenhout (Eds.), When Can Oil Economies Be Deemed Sustainable? (pp. 153–190). Springer. https://doi.org/10.1007/978-981-15-5728-6_7

Sims, C. A. (1980). Macroeconomics and Reality. Econometrica, 48(1), 1–48. https://doi.org/10.2307/1912017

Sobrino, C. R. (2013). The twin deficits hypothesis and reverse causality: A short-run analysis of Peru. 7. Statistical Review of World Energy | Energy economics | BP. (n.d.). Retrieved October 31, 2018, from https://www.bp.com/en/global/corporate/energy-economics/statistical-review-of-world-energy.html

Stock, J. H., & Watson, M. W. (2011). Introduction to econometrics (3rd ed). Addison-Wesley.

Stoker, T. M. (1993). Empirical Approaches to the Problem of Aggregation Over Individuals. Journal of Economic Literature, 31(4), 1827–1874.

Summers, L. (1986). Tax Policy and International Competitiveness (No. w2007). National Bureau of Economic Research. https://doi.org/10.3386/w2007

Vamvoukas, G. A. (1998). The relationship between budget deficits and money demand: Evidence from a small economy. Applied Economics, 30(3), 375–382. https://doi.org/10.1080/000368498325895

Van Schaik, J. (2015, November 30). When the Price Is Right. Natural Resource Governance Institute. https://resourcegovernance.org/analysis-tools/publications/selling-citizens-oil

World Economic Outlook Database, October 2020. (n.d.). IMF. Retrieved October 25, 2020, from https://www.imf.org/en/Publications/WEO/weo-database/2020/October ` Xie, Z., & Chen, S.-W. (2014). Untangling the causal relationship between government budget and current account deficits in OECD countries: Evidence from bootstrap panel Granger causality. International Review of Economics & Finance, 31, 95–104. https://doi.org/10.1016/j.iref.2014.01.014