Testing the Twin Deficit Hypothesis: The Case of Central and Eastern European Countries

Recent developments in the economies of the CEE countries bring into question the validity of the twin deficit hypothesis since we observed combination of high current account deficits and prevailingly stable fiscal positions before the crisis and just the opposite combination after it. The paper starts with the analysis of the theoretical foundations of the twin deficit hypothesis and the alternative explanations about the relationship between current account and fiscal deficits. Different econometric techniques are applied to test the validity of diverse theoretical approaches on the basis of panel data for CEE countries. OLS panel regression shows relatively modest positive connection between current account and fiscal deficits what confirms the twin deficit paradigm. On the other hand, the twin deficit hypothesis can be rejected in the case of Bulgaria and Estonia. The vector autoregressive analysis is also not compatible with the twin deficit hypothesis. Further research is necessary to overcome these contradictory results.