Budget Deficit Persistence and the Twin Deficits Hypothesis

Posted: 9 Sep 1996

See all articles by Michel Normandin

Michel Normandin

HEC Montreal - Institute of Applied Economics

Date Written: February 1996


This paper gauges the causal relationship between external and budget deficits by using Blanchard's overlapping generations model. This model tests the twin deficits hypothesis (i.e., there is a positive relationship between the deficits) and the Ricardian equivalence hypothesis (i.e., there is no link between the deficits). This model also implies that consumers forecast future budget deficits using (at least) the history of the two deficits. This implication is used to derive time series restrictions, which are testable for given consumers' planning horizons. For the relevant horizon, the response of the external deficit to an increase in the budget deficit is computed. For the Canadian and the U.S. economies, the relevant horizons can be as long as 83 years. However, given the persistence of the budget deficits, these horizons produce responses that are statistically significant. These findings reconcile the mixed results obtained in previous analyses.

JEL Classification: E62, F32, F41

Suggested Citation

Normandin, Michel, Budget Deficit Persistence and the Twin Deficits Hypothesis (February 1996). Available at SSRN: https://ssrn.com/abstract=3299

Michel Normandin (Contact Author)

HEC Montreal - Institute of Applied Economics ( email )

3000, ch. de la Côte-Ste-Catherine
Montréal, Quebec H3T 2A7

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