Fiscal Deficits, Current Deficits and Investment: A Panel Causality Framework of 20 OECD countries

This paper assesses the presence of a causal relationship and the impact of budget deficits and investment spending on current account deficits using data for 20 OECD countries for the 1974-2008 period. The analysis adapts the Ganger causality technique to a panel data framework through the Arellano-Bond difference GMM estimator. The estimation finds the presence of a causal relationship between budget deficits and current account deficits as well as between investment and current account deficits. Growing budget deficits lead to higher current account deficits, especially in the short-term. This twin deficit effect is eroded in the medium term and appears to be small in the long-run. Increases in investment spending have a similar effect over time, causing the current account to worsen particularly in the short term.