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Analysis Study Research Paper | Finance | Macedonia | Volume 12 Issue 4, April 2023

Twin Deficits: The Case of North Macedonia

Rilind Ademi | Zana Beqiri Luma

Abstract: The empirical and the theoretical literature have not yet reached a consensus on the causal link between the budget deficit and the current account deficit. Neo-Keynesian theory and the New Cambridge School in particular (but also monetarist theories) postulate the existence of a causal relationship between fiscal and current account deficits. The neoclassical or the rational expectations approach postulates the existence of an opposite relationship: as the government increases its budget deficit, the private sector saves more, which leads to a reduction in the current account deficit. We test the validity of the twin deficit hypothesis for the Republic of North Macedonia using quarterly data for the budget and trade deficit during the period Q1 2006- Q4 2021. Using the Granger causality and a vector autoregressive (VAR) model results partially confirm the twin deficit hypothesis. The weak relation we find between the budget and the trade deficit is not surprising for a small open economy such as North Macedonia, with a fixed exchange rate regime and with foreign direct investments which are mainly driven by the overall business conditions of the country rather than the prevailing interest rates. We find the fiscal policy to be of limited importance for the external position of the country, and call for policies that utilize the comparative advantage of the country, that promote and enhance the quality of goods and services in order to improve the competitive standing of the country in the regional and the global economy.

Keywords: twin deficit, North Macedonia, Granger causality, VAR model

Edition: Volume 12 Issue 4, April 2023,

Pages: 1035 - 1042