Time series analysis of the relationship between budget deficits and current account deficits in Turkey

Twin deficits hypothesis suggests that there is a positive relationship between budget deficits and current account deficits. According to twin deficits hypothesis, budget deficits causes current account deficits. This two deficits occur simultaneously and tend to follow a common trend. However, followers of the Ricardian approach have criticised this suggestion which reflects a Keynesian point of view and argued that such a relation between budget deficits and current account deficits does not exist at all. Thus, this controversy about the validation of the twin deficits hypothesis has became one of the major investigation issues in open economy maroeconomics and caused a big debate both in theoretical and empirical sense. This study aims to address the question whether twin deficits hypothesis holds for Turkey and to investigate the structure of the relationship between budget deficits and current account deficits if it exists. In order to test validation of twin deficits hypothesis quarterly data is used for the period 1987:01-2005:04 and a vector autoregression (VAR) technique has been employed to test for the existence and direction of causality between budget deficits and current account deficits. Our test results supports the validation of the twin deficits hyphothesis for the specific case of Turkey. The emprical results presented in this dissertation point out that, budget deficits lead to current account deficits via interest rates and exchange rates and that budget deficits is directly affected by current account deficits in Turkey for the period of 1987:01- 2005:04.