Macroeconomics tell that twin deficits occur when a particular country has both deficits involving its budget and the value of trades and investments going in and out or more specifically, if it has both fiscal deficit and current account deficit. The twin deficits hypothesis further explains that there is a strong causal link between the government budget balance of a country and its current account balance.
Difference Between Fiscal Deficit and Current Account Deficit
To understand further what twin deficits are, it is important to understand the difference between fiscal deficit and current account deficit. Take note of the following:
• Fiscal Deficit: A fiscal deficit is one of the three types of a budget deficit that occurs when the total spending of the government exceeds the total revenues it receives. More specifically, it represents the excess of total expenditures over total receipts, excluding the borrowings in a given fiscal year.
Hence, it indicates the amount the government needs to borrow to meet all of its expenses, including its normal functions and the delivery of its services. A large fiscal deficit means a large amount of borrowing. It is calculated by subtracting Total Expenditures with Total Receipts Excluding Borrowings.
• Current Account Deficit: A current account deficit is a measure of trade and financial transactions that occurs when a country is importing more goods and services than it exports. Note that the current account is the record of the value exports and imports of both goods and services and international transfers of capital.
To be more specific, it represents a situation in which a country is sending more money overseas to import or purchase goods and services from other countries than it is receiving from exports. Hence, the total value of the goods and services it imports exceeds the total value of goods and services it exports.
Intuition tells that having both fiscal deficit and current account deficit or twin deficits is not good. A budget deficit essentially tells that the government is not generating enough revenues from taxes and other income-generating activities to cover all of its expenses, thereby requiring to borrow money from domestic and foreign creditors.
On the other hand, a current account deficit can be an indicator that a particular country has lost its competitiveness, especially the attractiveness of its exports in the global trade market, as well as its attractiveness in the international capital market, while also losing its self-sufficiency because of dependence on imports and foreign capital.
But both deficits are not as straightforward as their definitions in reality. The United States has been running twin deficits for several years. However, it remains an attractive country for international individual and institutional investors. It is also interesting to note that developing countries even run current account surpluses.
