Investigating for Twin Deficits Hypothesis in South Africa

Abstract

This study examines the empirical relationship between fiscal deficit and current account imbalance employing data for South Africa for the period of 1960 to 2012. We employ co-integration analysis and VAR granger non causality process to investigate the existence of short term causalities for the economy under consideration as no long run steady-state relationship was established among economic variables of interest. The results indicate no evidence of twin deficits hypothesis for South Africa in the short-run. The absence of evidence of the twin deficits phenomenon for South Africa in the short-run time frame, suggests that the Ricardian equivalence proposition (REP) holds for the economy under consideration within such time horizon. This concept is of the view that since people are rational, they know that the reduction in taxes, resulting from the  government expansionary fiscal policy of tax cut or increase in public debt, is temporal and will save the extra disposable income to pay for the future higher taxes. This by implication suggests that the national savings position will be sustained because the decrease in government savings represented by increased fiscal deepening will be adequately compensated by the additional precautionary private savings for expected future increase in taxes. This indicates lack of responsiveness of private consumption to fiscal impulse and thus casts doubts on the efficacy of the use of fiscal policy in the management of external balance. In effect, this suggests that fiscal policy should not be intended for improvement in current account balance or in the least should not be used in isolation to supervise developments in current account stance in the short-run for South Africa. On the other hand, the results further provide evidence of the existence of current account targeting scenario for South Africa in the short run. Current account targeting hypothesis posits positive and significant causal relation between budget deficits and currents account deficits with current account balance causing budget balance. This suggests that current account balance may be intended for improvement in fiscal balance, indicating that the use of current account balance to supervise developments in fiscal deficits in South Africa may prove effective in the short-run.

Key words: Budget Deficits; Current Account Deficits; Co integration;Causality; South Africa