The twin deficit hypothesis: case of the Gambia

Abstract

This paper investigates whether the popular twin deficit hypothesis holds in the case of the Gambia, using time series data for a 34-year period (1972-2005). The study employed the bound co integration approach for examining the long run relationship and short-run temporal causality between the two deficits. The study results confirmed the existence of a long-run co integration relationship between budget deficit, money supply, GDP, world GDP, exchange rate, lending (interest) rate, consumer price index (inflation) and current account deficit. The empirical finding rejects the twin deficit hypothesis for the case of the Gambia by coming up with a negative short-run relations and a non-significant long run relationship between the two deficits. This means that budget deficit does not cause current account deficit and indicates the possibility of Ricardian Equivalence Proposition, as with the findings of Barro (1989), Evans (1988) and Ayodele et al. (2002). That is to say, economic agents should anticipate that budget deficits would be financed by rise in future taxes.