Twin Deficit Hypothesis In The Presence Of Structural Breaks In Nigeria

Empirical studies on twin deficit debate have focused on how current account imbalances are related to budget imbalance without considering underlying structural forces associated with domestic economy. The basic objective of this paper is to examine the effect of structural break on the validity of twin deficit hypothesis in Nigeria and to examine the dynamic interaction among the variables. The study employs the ARDL approach, variance decomposition, VAR-impulse response and Granger causality test to show dynamics between budget deficit and the current account deficit in Nigeria. The empirical results from ARDL indicate that budget deficit exerts a positive effect on the current account deficit both in the long run and short run implying the validity of twin deficit hypothesis in Nigeria. Granger causality test confirms no causality between the twin deficits. The impulse response result also reveals negative effect of shock in fiscal deficit on current account deficit while variance decomposition result shows that current account deficit substantially influences fiscal deficit variance. However, from all the methodologies adopted, structural break does not significantly affect the relationship between the deficits. The policy implication is that persistent increase in budget deficit tends to deteriorate current account balance. Therefore, government of Nigeria should exercise caution in using budget deficit to influence current account deficit even when structural break effect is considered.