Dynamic Linkages and Granger Causality between Trade and Budget Deficits : Evidence from Africa

This paper provides new evidence on the long-run relationship between trade and budget deficits in ten African countries over the quarterly period 1973:2 - 2005:4. Cointegration analyses are based on four approaches: Harris-Inder (1994), Shin (1994), Geweke and Porter-Hudak (1983) and Sowell (1992). In conformity with theoretical considerations, our analysis reveals that there is a positive long-run relationship between the trade deficit and the budget deficit; however, in the short run, we find weak evidence that these deficits are closely linked and that the budget deficit causes the trade deficit. The analysis finds that bidirectional long-run causality between deficits receives strong empirical support. Unidirectional causality and no causality characterize the short run, so bidirectional causality was found to be largely unimportant. Budget deficit adjustment, not trade deficit adjustment, is shown to be the key engine governing the speed of budget-trade deficit convergence; that is, the budget deficit is the primary variable that changes in order to restore equilibrium when the system has been subjected to shock. Moreover, budget deficits are found to converge much faster than trade deficits