Twin deficits hypothesis

In macroeconomics, the twin deficits hypothesis or the twin deficits phenomenon, is the proposition that there is a strong causal link between a nation's government budget balance and its current account balance. In macroeconomics, the twin deficits hypothesis or the twin deficits phenomenon, is the proposition that there is a strong causal link between a nation's government budget balance and its current account balance. Standard macroeconomic theory points to how a budget deficit can be a contributing factor to a current account deficit. This link can be seen from considering the national accounting model of the economy: where Y represents national income or GDP, C is consumption, I is investment, G is government spending and X–M stands for net exports. This represents GDP because all the production in an economy (the left hand side of the equation) is used as consumption (C), investment (I), government spending (G), and goods that are exported in excess of imports (NX). Another equation defining GDP using alternative terms (which in theory results in the same value) is where Y is again GDP, C is consumption, S is saving, and T is taxes. This is because national income is also equal to output, and all individual income either goes to pay for consumption (C), to pay taxes (T), or is saved (S). Since Y = C + I + G + N X {displaystyle Y=C+I+G+NX} , and Y − C − T = S {displaystyle Y-C-T=S} , then S = G − T + N X + I {displaystyle S=G-T+NX+I} , which simplifies to the sectoral balances identity ( S − I ) + ( T − G ) = ( N X ) {displaystyle (S-I)+(T-G)=(NX)} If (T-G) is negative, we have a budget deficit.