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| Identifying the Role of Government Debt on Twin Deficits |
| LIN Feng, DENG Kebin
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| School of Economics and Commerce/ Research Center on Supply-Chain Finance Engineering of Guangdong Province, South China University of Technology |
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Abstract Whether the government debt affects the twin deficits is an important issue in the international trade research. Due to the serious endogeneity between the fiscal deficit and the current account deficit, empirical research has not been concluded in agreement with theoretical research. This paper introduces the duration of education as an effective instrument variable for fiscal deficit to solve this problem. Using panel data from 150 countries in 2000 to 2014, including developed countries, emerging markets and developing countries, the empirical evidence is in line with theoretical expectations. Firstly, with a increase in government debt, the twin deficits tend to weaken. Secondly, the twin deficits in high-debt countries tend to be weaker than low-debt countries, but sill significant. Thirdly, the role of government debt on twin deficits is mainly reflected in developing countries, while which is relatively vague in developed countries due to endogeneity concerns and other disturbances including monetary policy. It is found that expansionary fiscal policy would lead to a significant reduction in current account surpluses for developing countries with low government debt such as China. For developed countries that are already at a high government debt, strategies to regulate current account imbalances through tight fiscal policy should play with proper monetary policy and be independent from the reverse impact of current account imbalances on fiscal policy.
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Received: 08 November 2017
Published: 01 November 2018
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