Relation between Current Deficit – Budget Deficit and Two Different Comments

To summarize it shortly, current accounts, which is one of the sub-titles of balance of payments, is the value obtained by adding investment revenues current transfers (interest, rant and commercial revenues) to the difference between exports and imports of goods and services of a country. Budget balance is budget revenues aimed in public budget within the framework of economic targets planned for economic stability, growth and employment in the same year (mostly composed of taxes, T) being equal to the aimed government expenditures (G). Moving from that point on, for both of them respectively current deficit indicates a negative value for balance of goods and net investment revenues; budget deficit means that government revenues are lower than government expenditures. Usually in macroeconomics it is accepted that these two processes are in a relation of mutual causality with each other. When we look at the history of economics, this phenomenon is analysed by two different opinions. On one hand, Keynesian approach (which accepts the twin deficits relation), and on the other hand Ricardoan equality hypothesis approach (which rejects twin deficits relation). Before examining these approaches in detail, it is very important to show moving from national income the relation between balances of trade, budget and savings and from there to reach the general table between current balance and budget balance so that we can understand these two different interpretations.

(1)GDP = C + I + G + NX = C + S + T

first, inputs and outputs of gross national product will be equal.

(2)I + G + X = S + T + M

departing from the second indicator, we can show this relation between budget deficit and trade deficit as follows:


(3)(X-M) = (S-I) + (T-G) in other words we can define this as GB = SB + BB

GB (balance of goods) shows the current accounts deficits indicating the difference between exports and import of goods and services, SB (savings balance) shows the difference between savings and investments of private sector and finally BB (budget balance) shows the difference between planned government revenues and expenditures. Under the light of these explanations, we can now look at the opinions about twin deficit phenomenon. According to Keynesian view, if public expenditures of a country with flexible exchange rate and free capital movement increase, national savings decreases. The reduction of national savings is a warning for government authorities to increase interest rates. The increase of interest rates whets the appetite of foreign investments (the most typical example is hot money) and creates an abundance of foreign currency in the country and causes national money to gain value. Naturally the national money which is now stronger compared to foreign currencies distorts the balance of goods, which is an element of current accounts balance to the disadvantage of exports and current accounts deficits begin to form due to the serious trade deficits. As a result, depending on the increase of government expenditures, budget deficit has a negative impact on current accounts balance and creates the phenomenon of twin deficit. On the other hand, there is Ricardoan equality hypothesis which rejects twin deficit phenomenon. According to this view, due to tax reductions in balance of budget, budget deficit does not create an impact on the current accounts balance. If it is accepted that government expenditures are fixed and there is no possibility of borrowing, the reduction in tax rates does not affect level of savings. People increase their private savings due to reduced tax burden. Due to tax reductions private savings will be affected equal to the decreased public expenditures; therefore national savings level will remain unchanged and current accounts balance will not be affected. Thus, according to Ricardoan equality hypothesis, the phenomenon of twin deficits is not acceptable.

Resources:

1)Ahmet AY - Zeynep KARAÇOR - Mehmet MUCUK - Savaş ERDOĞAN – THE RELATION BETWEEN BUDGET DEFICIT AND CURRENT ACCOUNTS DEFICIT: THE CASE OF TURKEY (1992-2003)

2)Prof.Dr. Tümay Ertek – INTRODUCTION TO MACROECONOMICS