Academic journal article Journal of Economic and Social Studies

Twin Deficit in Nigeria: A Re-Examination

Academic journal article Journal of Economic and Social Studies

Twin Deficit in Nigeria: A Re-Examination

Article excerpt

(ProQuest: ... denotes formulae omitted.)


In empirical literature, there are two major theories that are used to explain the causal link between budget deficit and current account deficits. These are the Mundell-Fleming Model of Exchange Rate Regime and the Ricardian Equivalence Hypothesis (REH). The traditional Keynesians use the Mundell-Fleming model to explain the twin deficit relationship and they argued that when budget deficit increases, the current account balance will deteriorate as the increases in the budget deficits will drive up domestic interest rates, real exchange rate and rate of capital inflows. On the other hand, while acknowledging the detrimental effects of large fiscal deficits on the economy, the critics of the Mundell-Fleming model have disputed the sequence of causation implied by the model (Harshemzadeh and Wilson, 2006). These groups of researchers used the Ricardian Equivalence Hypothesis (REH) to argue that no relationship exists between the two deficits as budget deficits results mainly from tax cuts which tend to reduce public revenue and public savings. They opined that individuals will perceive these tax cuts as incurring future tax liabilities and thus will increase savings rather than consumption.

Nigeria, experiences over the years have shown that there have been periods of persistent and rising budget deficits as well as periods with current account deficits. As such, it is evident that the Nigerian economy has been experiencing the twin deficit phenomenon. In the same vein, Nigeria as an oil-exporting country where revenue from oil production contributes more than 95% of its foreign exchange, 40 percent of GDP and 80 percent of fiscal revenues makes the economy susceptible to fluctuations in government revenues as a result of volatility in oil revenue (Onafowokan and Owoye, 2006).

In Nigeria, two studies are of prominence in this respect, these are Egwaikhide (1997), Egwaikhide et al (2002) and Onafowokan and Owoye (2006). Egwaikhide (1997) examined the effects of budget deficits on the current account balance in Nigeria and concluded that quantitative evidence suggests that budget policy affects the current account balance for Nigeria. Egwaikhide et al (2002) in their paper on causality between budget deficit and current account balance for a number of African countries, found a unidirectional causality from the budget deficits to the current account deficits to exists for Benin, Burkina Faso, Ghana, Nigeria and South Africa. Onafowokan and Owoye (2006) examined the relationship between budget and trade deficits. Their findings showed evidence of positive relationship between trade and budget deficits in both the short and long run but that causality is unidirectional running from trade deficits to budget deficits.

Apart from the fact that these studies in Nigeria utilized a bivariate framework commonly used in previous empirical studies which this study tends to improve upon by using a multivariate framework of Granger causality analysis, available data from the last ten years showed that the two deficits have not been moving together as argued by the two studies (Egwaikhide, 1997 and Onafowokan and Owoye, 2006) that were previously done for Nigeria. The most recent study to the best of my knowledge was carried out in 2006 and between then and now; there could have been some adjustment. Consequently, it becomes imperative to re-visit and re-examine the validity of the twin deficit phenomenon for Nigeria.

As it is believed in open economy macroeconomics that budget deficit leads to deterioration of the current account balance (Jayaraman et al, 2008), it therefore becomes imperative to find out if the resulting current account balance experienced by the Nigerian economy is as a result of the substantial increase in its budget deficit over the years as has been argued by the twin deficit hypothesis or it is the other way round. This thus raises some pertinent questions like - Is the twin deficit hypothesis still valid for Nigeria? …

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