Project Materials

A RE-EXAMINATION OF THE TWIN DEFICIT PHENOMENON IN THE NIGERIAN ECONOMY

Chapter one

INTRODUCTION

1.1. Background of the Study

The “Twin deficit” dispute was a prominent policy issue in the 1980s and early 1990s, and the term was first used to characterise the co-movement of the US budget deficit and current account deficit (Chang and Hsu, 2009). Researchers then began using it in other nations.

Since then, academics have been interested in investigating the causal link between the two deficiencies, as well as the direction of causality.

The simultaneous emergence of budget deficits and current account deficits in most countries, particularly the United States (US), in the mid-1980s led to the characterisation of this phenomenon as the “twin deficits” issue, as both economic theory and empirical observation suggested a link between the two deficits (Chinn, 2005).

Thus, the twin deficit theory has emerged as one of the most important links among aggregate economic variables. Over time, however, there has been a renewed interest in understanding the relationship between the budget and the current account deficit.

According to Giancarlo et al. (2006), the fiscal deterioration in the United States under the first George W. Bush administration, along with persistent US trade deficits, refocused attention on the twin deficit issue.

Chang and Hsu (2009) added to this by adding that the recurrence of massive budget and trade deficits in the United States since the turn of the century has reignited public interest in the relationship between the twin deficits.

Yanik (2006) further stated that the relationship between current account deficits (CAD) and budget deficits (BD) is now the focus of international macroeconomics research.

It is believed that the two deficits will move together in the long run. The twin deficit hypothesis, based on international macroeconomics, proposes that changes in a country’s budget deficit can lead to changes in its current account balance, or vice versa. This relationship, however, is thought to occur via the channels of real interest rate, real income, and real exchange rate.