An Empirical Investigation for the Twin Deficits Hypothesis in Pakistan

Pakistan constitutes a valuable case study for investigating the dynamics of persistently high rates of budget and current account deficits. In this paper an attempt has been made to empirically test the twin deficits hypothesis in Pakistan using quarterly time-series data for the period 1975 to 2005. The co-integration results indicate the existence of a longrun relationship between the deficits, while the Granger-causality test shows that bi-directional causality runs between the two variables. This finding casts doubt on the validity of the use of single-equation approach to analyze the twin deficits hypothesis. This implies that a more fruitful inquiry into the relationship between budget and current account deficits should be performed in the context of a simultaneous-equation model.