GROUP MEMBERSMUHAMMAD

DANISHAHSAN MAQBOOL

AMEER ALI MUGHAL

AGENDA1) INTRODUCTION

2) HISTORY

3) DEFINITION

4) DERIVATION

5) APPROACHES

6) ASUMPTIONS

7) ALLIGATIONS

8) GENERAL FINDINGS

9) CASE STUDY 1.PAKISTAN 2.USA

INTRODUCTIONTwin-Deficit Identity is one of the important

relationships among aggregate economic variables.

It is a term in reference to a country’s government budget deficit and a simultaneous current account deficit.

The twin deficits hypothesis is a concept from macroeconomics that contends that there is a strong link between a national economy's current account balance and its government budget balance.

HISTORYThe name for this identity became

commonplace during the 1980s and 1990s as the US experienced deficits in both of these accounts.

In fact, some countries will, at times, experience a deficit on one account and a surplus on the other. (witness Japan in 2000)

Sri lanka is experiencing twin deficit since 1960.

There is no reason that "twin" deficits need always appear together on these two national accounts

DEFINITION Thus, a better title to this section would be,

“The Relationship Between a Country’s Government Budget Deficit and its Current Account Deficit.”

Y = C + I + G + NX Where, Y = National Income or GDP, C = consumption, I = investment, G = government spending and NX = net exports.

Why GDP? As all the production in an economy (the left

hand side of the equation) is used as consumption (C), investment (I), or government spending (G), and the leftover production is exported (NX).

Another equation defining GDP using alternative terms (which in theory results in the same value) is

Y = C + S + TWhere Y is again GDP, S is savings, and T is

taxes.National income is also equal to output, and all

individual income either goes to pay for consumption (C), to pay taxes (T), or becomes savings (S).

PROOF Since,1. Y = C + I + G + NX, and Y = C + S + T

2. then C + I + G + NX = C + S + T

3. which simplifies to (S − I) + (T − G) = (X − M)

4. If (T-G) is negative, we have a budget deficit.

We can thus substitute for:Savings + TradeDeficit = Investment + BudgetDeficit.

Rearranging algebraically we find that:BudgetDeficit = NetSavings + TradeDeficit − Investment.

APPROACHES MUNDELL-FLEMING MODEL

An increase in budget deficit will exert upward pressure on domestic interest rates.

Therefore causing Capital inflow and exchange rate to appreciate.

Hence deteriorating current account balance.

APPROACHES RICARDIAN EQUIVALENCE HYPOTHESIS

It negates the link between two deficits.

They argue that present cut in taxes or increment in government expenditure do not alter current consumption and in vestment.

As the present tax cut becomes a burden in the future.

The Keynesian income-expenditure approach explains the mechanism behind this twin deficit relationship.

1. It says that increase in the budget deficit will increase domestic absorption in the economy raising up income level.

2. This increase in the income level would induce imports and resultantly the deficit in the trade balance will be increased.

APPROACHES KEYNESIAN APPROACH

The body of evidences has not yielded a consensus on the casual relationship between the two deficit.

Researchers such as Ibrahim and Kumah(1996), Islam(1998), Vamvoukas(1999), Piersanti(2000), Leachman and Francis(2002) supports the conventional view i.e.,

“ worsening budget deficit stimulates & increase in current account deficit”

ASSUMTION

1.The two variables are mutually dependent.

2.The casualty runs from current account deficit to budget deficit, termed as “ current account targeting”.

ALLIGATION“Twin deficit phenomenon” is grossly mis-

specified, as it excludes all other relevant variables, such as saving and investment.

General FindingsReasons for Budget deficit are,

1)Decreased government revenue (due to narrow tax base & inefficiency of tax collection)

2)Increased Public expenditure (on food subsidies and defense)

Traditional macroeconomics predicts that persistent double deficits will lead to currency devaluation/depreciation that can be severe and sudden.

EXAMPLE (USA)

In the US, the budget deficit is financed about half from foreigners, half domestically.

"Double deficit" in the USA. Fiscal balance (black) and current account balance (red). Source: ameco

EXAMPLE (PAKISTAN)Pakistan has been facing a major problem of

high trade deficit for several years. This deficit is increasing rapidly.

During the fiscal year 2008 this deficit was at highest level of Rs.1,304.15 billions, which is 108% of total exports (Rs.1,208.12 billion)

On the other hand fiscal deficit has also deteriorated. Table below, shows the value of trade deficit and budget deficit, recorded since 1976 to 2008.

S.No Years Trade Deficit Budget Deficit

1 1976 9212 13065

2 1977 11718 13261

3 1978 14835 14416

4 1979 19463 18250

5 1980 23519 16127

6 1981 24264 16637

7 1982 33212 19076

8 1983 33709 27940

9 1984 39368 27712

10 1985 51799 39416

11 1986 11354 44586

12 1987 29076 48529

13 1989 34106 63352

14 1989 45658 62068

15 1990 42384 62840

PAKISTAN TRADE AND BUDGET DEFICIT 1976-2008 (Rs in million)

16 1991 32832 89193

17 1992 58161 89971

18 1993 81615 107525

19 1994 52751 92179

20 1995 69719 105352

21 1996 102834 137839

22 1997 139688 156588

23 1998 63178 204560

24 1999 75622 179177

25 2000 90114 196600

26 2001 87930 164900

27 2002 73683 202150

28 2003 62078 177400

29 2004 188789 162000

30 2005 368991 216967

31 2006 726317 325300

32 2007 822494 502011

33 2008 1304153 683400

GRAPHICAL ANALYSIS OF PAKISTAN’S

TRADE AND BUDGET DEFICIT 1976-2008 (Rs in million)

RECOMMENDATIONTrade and financial reforms are recommended tools

for boosting economic performance via efficiency gain “Still success is not guaranteed as foreseen”

Trade openness driven by reforms in trade & financial sectors can alleviate current account difficulties

Uprising of China and India are examples of the effect of “Trade liberalization”

SOURCES:

http://jang.com.pk/thenews/aug2009-weekly/busrev-17-08-2009/p8.htm

TWIN TRADE TWIN TRADE ARTICLE BY SIR LIAQAT ALISIR LIAQAT ALI

ECONOMIC SURVEY OF PAKISTAN

STATISTICAL BUREAU OF PAKISTAN