General Equilibrium Perception on Twin Deficits Hypothesis: An Empirical Evidence for the U.S.

Transcription

1 Deparmen of Economics Issn Discussion paper 09/09 General Equilibrium Percepion on Twin Deficis Hypohesis: An Empirical Evidence for he U.S. Tuck Cheong Tang * and Evan Lau Absrac: From he general equilibrium percepive, his sudy proposes he inclusion of privae savings and invesmens in examining win deficis hypohesis. Using U.S. daa, he empirical resuls suppor win deficis hypohesis bu he budge defici s elasiciy is decreasing from uniy o Key words: General Equilibrium; Governmen Budge Deficis; Curren Accoun Balance; U.S. JEL classificaions: F32; H62 * Corresponding auhor. Monash Universiy Sunway campus. ang.uck.cheong@buseco.monash.edu.my Corresponding auhor. Universii Malaysia Sarawak (UNIMAS) Tuck Cheong Tang and Evan Lau All righs reserved. No par of his paper may be reproduced in any form, or sored in a rerieval sysem, wihou he prior wrien permission of he auhor. 1

2 1. Inroducion A series of papers in a special issue of Journal of Policy Modeling (Vol. 28 No.6, pp , 2006) dedicaes a subsanial debae on Twin deficis, growh and sabiliy of he US economy. Evenually, here is a subsanial volume of sudies available in he lieraure describes he heoreical framework and empirical resuls abou he possible linkages (and comoving) beween governmen budge defici (BD), and curren accoun defici (CAD). Concern raise up by Obsefeld and Rogoff (2005) and Mendoza e al., (2007) ha unless major policy acions are aken, hese imbalances will generae global financial urbulence and he curren crisis can be viewed as he oucome of hese episodes. Hisorically, he so-called win deficis hypohesis arose during he Reagan fiscal experimen in he 1980s, marked a period of srong appreciaion of he dollar wih unusual shif hike in curren accoun deficis. Several observaions have confirmed ha he unsusainable budge defici during hese periods has widens curren accoun balances (Darra, 1988, Bachman, 1992, Leachman and Francis, 2002). By and large, he exising sudies on win deficis phenomenon are mainly focused on he inerrelaionships and/or comoving relaion in a bi-variae framework beween budge deficis and rade balances (or curren accoun balances). Ineresingly, Cavallo s (2005) aricle eniled Undersanding he Twin Deficis: New Approaches, New Resuls has highlighed ha oher hings are no always equal, and a number of facors may affec how much budge deficis explain curren accoun deficis. Using he derivaion from general equilibrium percepion, his sudy proposes an alernaive framework o es he win deficis hypohesis in which wo addiional macroeconomics variables i.e. privae savings, and domesic invesmens are included. This sudy demonsraes an empirical suppor of win defici hypohesis by using he U.S. daa. Nex secion discussion he win deficis hypohesis in erms of general equilibrium percepion, and secion 3 repors he daa, and resuls. Secion 4 concludes he secion. 2. Theoreical Framework The concepual undersanding of he win deficis hypohesis is heoreically buil from he commonly documened idenify - naional income ideniy: 2

3 Y = C + I + G + NX (1) where Y is real GDP, C is privae consumpion, I is invesmen, G is governmen purchases, and NX is ne expors which is he differen beween expors (X) and impors (M). And, he NX is also called CAB (curren accoun balance). A rewriing of he naional income ideniy, he CAB relaion can be delivered as following: NX = (Y C G) I CAB = (Y C G) I (2) Again, he naional saving, S is he naional income afer subracing he spending on goods and services by privae (C) and public (G) secors. CAB = S I (3) where S = S p + S g. S p is privae saving which is derived from Y T C, while S g is governmen saving T G. T is ax revenue. If, T > G indicaes budge surplus (BS). Bu for he case T < G, he Governmen budge is in deficis (BD). From he general equilibrium relaion (3), he balance budge occurred when T = G. The win deficis hypohesis can be expressed in he following relaion. CAB = BD + S P I (4) Oher hings being equal, a precise focus on his relaion yields wo heoreical observaions. Firs, here are possible for a leas one coinegraing relaion or long run equilibrium among he variables CAB, S P, BD, and I. More precisely, one of he long run relaion idenified by sandard economic heory is CAB and BD relaion. The second observaion is a posiive impac of BD on CAB (i.e. win deficis hypohesis), in which oher heoreically jusified variables (privae savings and invesmens) do play a role in validaing his relaionship as noed early in Cavallo (2005). Conversely, he win deficis hypohesis is hold if he esimaed coefficien of BD (equaion 4) is saisically difference from zero a convenional levels i.e. 10%, 5%, or 1%. 3. Daa and Empirical Resuls Daa The U.S. daa for curren accoun balance (CAB), governmen budge balance (GB), invesmen (I), and privae savings (S p ) (i.e. subracing S wih GB) are obained from he 3

4 Inernaional Financial Saisics, IFS (Inernaional Moneary Fund, IMF). The variables are measured in real erms (and in $US billions) by deflaing he nominal value wih GDP deflaor. The sample period covers quarerly observaions beween 1973Q1 and 2008Q3. Table 1 shows he resuls of uni roo ess (ADF) ha all ime series are non-saionary in levels a 10% level of significance, expec for invesmen (I). All series are saionary in fis differenced form (a leas 0.10 levels). Table 1 Resuls of Augmened Uni Roo ess (p-values) Daa in levels Consan and rend Daa in firs difference Consan LnCAB LnGB LnI LnS p (11) (7) (12) (12) (13) (6) (12) (11) Noe: The number in (.) denoes he lag lengh suggesed by AIC from a maximum of 13 lags. Empirical Resuls On he oher hand, he resuls of Johansen s mulivariae coinegraion ess sugges a leas one coinegraing vecor among he four variables (i.e. l2 lags) which is consisen wih heoreical inuiion of wo coinegraing relaions as suggesed by heories, namely win deficis hypohesis (CAB and GB), and capial mobiliy hypohesis (S and I). Table 2 Johansen s mulivariae coinegraion ess Daa Trend: Tes Type None No Inercep No Trend Lags inerval: 1 o 4 Trace 1 Max-Eig 1 Lags inerval: 1 o 5 Trace 1 Max-Eig 1 Lags inerval: 1 o 12 Trace 2 Max-Eig 2 Noes; *Criical values based on MacKinnon-Haug-Michelis (1999). VAR Lag Order Selecion Crieria Schwarz informaion crierion and Hannan-Quinn informaion crierion sugges 4, and 5 lags, respecively. Sequenial modified LR es, Final predicion error, and Akaike informaion crierion 12 lags (maximum lag order) The win deficis hypohesis is ypically esed by a simple linear regression equaion i.e. LnCAB = b 1 LnBD + e. The OLS (ordinary leas squared) esimaion is presened as equaion (6). The esimaed elasiciy is found o be close o uniy,

5 LnCAB ˆ = LnBD (-raios) (90.350) (5) Implicily, he residuals series of his specificaion does capure he omied variables suggesed by equilibrium relaion (4), namely savings (S p ), invesmen (I) (or capial mobiliy). Thus, he esimaed residuals series of equaion (5) does no reflec coinegraion propery beween curren accoun balance, and governmen budge posiion, bu savingsinvesmen relaion. Following equaion (4), an OLS regression model can be esimaed i.e. CAB + p = b1 LnBD + b2lns b3lni e where b i are he esimaed parameers, and e is residuals. Firsly, he coefficiens of privae saving (S p ) and invesmen (I) are resriced as suggesed by heory i.e. b 2 = 1, and b 3 = -1. The OLS esimaor yields:- p LnCAB ˆ = LnBD + LnS LnI (-raios) ( ) (6) The elasiciy of BD is close o equaion (5). Consisenly, he resricions imposed on privae savings and invesmens reflec residuals series in equaion (5). Equaion (7) repors he esimaes of parameers of equaion (4) wihou any resricions. LnCAB ˆ p = 0.431LnBD LnS LnI (-raios) (6.293) (15.949) ( ) (7) All of he esimaed parameers are saisically difference from zero wih reasonable large - raios. Ineresingly, he esimaed coefficiens for privae saving (S p ) and invesmen (I) boh are no numerically equal o -1, and 1, respecively as heory suggess. The Wald es saisic (F-saisic) of esing he sum of coefficiens of S p, and I equals zero (i.e. H 0 : b 2 +b 3 =0) is (p-value is 0.000) rejecing he null hypohesis, and he elasiciy of budge defici on curren accoun balance is found o be inelasic, which is half of he values esimaed as equaions (6) and (7), bu i is saisically differen from zero (-raio is 6.293) supporing win deficis hypohesis for U.S. Undoubedly, his observaion furher suppors he heoreical view of omiing wo imporan variables viz. privae saving, and invesmen in esing win deficis hypohesis (see Cavallo, 2005). 4. Conclusion 5

6 This sudy proposes an alernaive esing framework o he win deficis hypohesis from he general equilibrium percepive, in which boh privae savings and invesmens are included. Empirical illusraion of using U.S. daa shows supporive evidence of he win deficis model derived from general equilibrium percepive. The budge defici elasiciy decreases (almos half) when he general equilibrium approach applied. I suppors he argumen made by Cavallo (2005). And, his sudy suggess an alernaive framework for win deficis hypohesis for furher research References Bachman, D.D. (1992). Why is he US curren accoun defici so large? Evidence from vecor auoregressions. Souhern Economic Journal, 59, Cavallo, M. (2005). Undersanding he Twin Deficis: New Approaches, New Resuls, FRBSF Economic Leer Number , July 22, Darra, A. F. (1988). Have Large Budge Deficis Caused Rising Trade Deficis? Souhern Economic Journal, 54, Leachman, L.L., & Francis, B. (2002). Twin deficis: appariion or realiy? Applied Economics, 34, MacKinnon, James G., Haug, Alfred A. and Michelis, Leo (1999). Numerical disribuion funcions of likelihood raio ess for coinegraion, Journal of Applied Economerics, 14, Mendoza, E. G., Quadrini, V. and Rios-Rull, J.-V. (2007). Financial Inegraion, Financial Deepness and Global Imbalances. Naional Bureau of Economic Research (NBER) Working Paper No

7 Obsfeld, M. and Rogoff, K. (2005). Global curren accoun imbalances exchange rae adjusmens. Brookings Papers on Economic Aciviy, 1,