The threshold effect of public debt on the twin imbalances: Evidence from MENA countries

ABSTRACT

The study explains the non-linear relationship between total public debt and twin imbalances, across a panel of 15 countries in the MENA (Middle East and North Africa) region from 2003 to 2019. A panel data threshold model with fixed effects proposed by Hansen (1999) estimates two debt-to-GDP thresholds (36.71% and 72.99%), which determine three debt-to-GDP intervals in the twin relationship. Our findings show two interesting results. First, if the level of public debt to GDP is less than 36.71%, the model determines a negative relationship between the budget balance and the current account. Twin deficits are confirmed exclusively if debt-to-GDP is in the interval between 36.71% and 72.99%. A twin divergence is also confirmed if public debt-to-GDP is more than 72.99% (e.g. as in Egypt and Lebanon). The results of this study show that there is not a single debt threshold applicable to all MENA countries, and the regression results are robust for different specifications and estimation techniques. As a result, policymakers may be able to adjust the current account deficit by lowering the public-debt ratio, reducing government-funded sterile programs, and implementing appropriate austerity measures to mitigate the effects of the financial crisis.

KEYWORDS:

• Fiscal deficit
• current account
• twin deficits
• twin divergence
• public debt
• panel data threshold model

JEL CLASSIFICATIONS:

• C10
• C62
• F32
• F41
• H63

Acknowledgements

The authors would like to express gratitude to the editor and anonymous referees for their insightful comments and suggestions which were useful in improving the quality of this paper. Any remaining errors are ours.

Disclosure statement

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