Revisiting the twin deficits hypothesis in the United States: Further evidence based on system-equation ADL test for threshold cointegration

Abstract

We revisit the twin deficits hypothesis (budget and trade deficits) for the United States during 1791–2019, using the system-equation ADL test for threshold cointegration proposed by Li (2017). This model can demonstrate the existence of both asymmetric adjustment and asymmetric role in the relationship between trade and budget deficits. Our empirical evidence suggests a nonlinear long-run relationship between the two variables, thus finding the presence of the twin deficits hypothesis. Further, we find time–varying cointegration between the two, and an asymmetric adjustment process. Budget deficits play a vital adjustment role at low regimes (when error-correction terms are below the threshold of 1.11), and trade deficits play an important adjustment role at higher regimes (when error-correction terms are above the threshold of 1.11).

KEYWORDS:

• Twin deficits hypothesis
• system-equation ADL test
• threshold cointegration
• asymmetric adjustment

JEL classifications:

• C22
• E62
• F32

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 https://fred.stlouisfed.org/series/FYFSD. Another version of twin deficit hypothesis (TDH) refers to trade deficits and budget deficits (see Antonakakis et al. 2019).

2 www. Ceicdata.com, Bureau of Economic Analysis.

3 http://liberalarts.oregonstate.edu/spp/polisci/research/inflation-conversion-factors-convertdollars-1774-estimated-2024-dollars-recent-year. Follow the work of the Antonakakis et al. (2019) we use both trade deficit and budget deficit to test the twin deficits hypothesis in our study.