TWIN DEFICIT HYPOTHESIS IN PAKISTAN: A NON-LINEAR APPROACH WITH STRUCTURAL BREAK

Abstract

In current scenario of surging current account deficits in Pakistan this study attempts to explore causes behind the phenomenon. It is also a fact that current account deficit and fiscal deficit are chronic troubles of Pakistan hence twin deficit hypothesis is the best candidate to be investigated. In earlier studies cointegration analysis was used to confirm the hypothesis but no study takes into consideration the structural break in the analysis which could mislead the findings. Therefore, in this study twin deficit hypothesis is investigated specifically in the presence of structural break. Gregory-Hansen test of co-integration is applied on data from 1980 to 2017 which confirms the long run relationship between current account deficit, fiscal deficit, real effective exchange rate, economic growth and fuel imports. Then in the perspective of structural break and long run relationship, ARDL methodology inclusive of dummy interaction terms validates twin deficit hypothesis in recent scenario of Pakistan. It is also concluded that proclaims of policy makers in Pakistan regarding catching up effect of growthforcurrent account deficit are found to be partially true because economic growth is inlong run relationship with current account deficit but itsroleis not yet clear.