TESTING TWIN DEFICITS HYPOTHESIS FOR EU-27 AND TURKEY: A PANEL GRANGER CAUSALITY APPROACH UNDER CROSS-SECTIONAL DEPENDENCE

Abstract

Twin deficits hypothesis has been one of the most widely-applied phenomenon in the economics literature. In this study, the twin deficits hypothesis was tested for the EU-27 member states and Turkey with the data covering the 2002: Q1-2014: Q1 period. Unlike other studies, the twin deficits hypothesis was tested by using second generation panel causality tests that considered the cross-sectional dependence. According to the findings of this study, which used panel Granger causality tests suggested by Dumitrescu-Hurlin (2012) and Emirmahmutoglu-Kose (2011), there is statistically significant bidirectional causality between budget deficit (BD) and current account deficit (CAD) in the relevant period. It was found out a bidirectional causality between BD and CAD in sixteen of the twenty-eight countries (Austria, Belgium, Bulgaria, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Italy, Netherlands, Romania, Spain, Turkey and the UK) and a unidirectional causality from BD to CAD was also noticed in five EU countries (Cyprus, Latvia, Lithuania, Poland and Slovakia). Nevertheless, the findings indicated that there is a unidirectional causality from CAD to BD in Hungary, Luxembourg and Malta but there is no causality between BD and CAD in Ireland, Portugal, Slovenia, and Sweden.