The Analyses of Structural Vector Autoregressive Model on the Twin Deficit Convergence among the Emerging Economies: Does Ricardian Equivalence Hypothesis Matter?

This study was motivated by the inconsistent conclusions in the literature on the twin deficit hypothesis (TDH) and the implications of the Ricardian equivalent hypothesis (REH). The study examined whether the REH (Ricardian savings behaviour) violates the occurrence of the TDH, especially under a fixed exchange rate regime with perfect capital mobility in a panel of 15 emerging markets for the period 1980-2021. The data were sourced from the World Bank statistical bulletin, and the structural vector autoregressive (SVAR) estimation technique was employed to analyse the data by imposing restrictions on private savings variable. The study found strong evidence of a positive co-movement between fiscal and trade deficits when the REH is violated by restricting savings. However, the TDH was violated when savings was not restricted. Also, both deficits exhibit strong endogenous and exogenous response of their own shocks and shocks from each other respectively when capital is perfectly mobile but have weak endogenous response of its own shocks when capital is relatively mobile. The study concluded that fiscal deficits deteriorates and transmits shocks to trade balance, especially when savings is held constant and capital is perfect mobility.