Twin Deficits: Squaring Theory, Evidence and Common Sense
Bibliographic record
Abstract
In this paper we reconsider the twin deficit hypothesis (that fiscal shocks generating budget deficits also worsen external trade) both from a theoretical point of view and by analyzing data for Australia, Canada, the UK and the US. First, we assess the joint dynamics of budget and trade deficits along the business cycle, uncovering a strikingly recurrent S-shaped relation between the two. The correlation is actually negative, suggesting twin divergence. This observation however cannot rule out the possibility that government spending expansions and/or tax cuts may cause trade deficits, as the overall correlation is likely to be dominated by cyclical factors. Second, we reconsider the transmission of government spending in a standard two-country two-good model: we find that openness and the persistence of fiscal shocks are major determinants of the magnitude (or even sign) of the response of the trade balance to fiscal shocks. For a given persistence of the fiscal shock, the closer an economy, the larger the crowding out effect on investment, the lower the deterioration of the trade balance. Third, we take this insight to the data, investigating the transmission of fiscal shocks in a VAR framework in the four countries in our sample. Our empirical findings tend to support our view. In the US and Australia, which are relatively less open than Canada and the UK, and where government spending shocks are less persistent, we find that the external impact of fiscal policy is rather limited. Instead, private investment responds substantially. The reverse is true for Canada and the UK. These findings confirm and put into perspective earlier results, whereas fiscal expansions in the US are found to have on average a negligible effect on the country's trade balance. However, we emphasize that these results are consistent with a call for a US fiscal retrenchment to address global imbalances: the impact of budget cuts on the US external trade is muted by their positive effect on domestic investment, strengthening the US ability to generate resources against future interest and debt repayment.
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How this classification was reachedexpand
Full frame machine prediction
Teacher imitationNot calibrated prevalence, not ground truth. Human validation pending. The Gemma side is a direct model label for every work in the frame, read from the title-only record. The Codex side is a classifier learned from the 10,348 direct Codex labels and calibrated to design-weighted sample rates; fields without enough sample support carry no Codex call. Candidate is the union of the two sides; consensus is their intersection. These outputs are machine_predicted_unvalidated and are not human labels.
Distilled classifier scores by category (both heads)
| Category | Codex | Gemma |
|---|---|---|
| Metaresearch | 0.016 | 0.061 |
| Meta-epidemiology (narrow) | 0.001 | 0.001 |
| Meta-epidemiology (broad) | 0.002 | 0.001 |
| Bibliometrics | 0.011 | 0.008 |
| Science and technology studies | 0.002 | 0.014 |
| Scholarly communication | 0.008 | 0.023 |
| Open science | 0.003 | 0.007 |
| Research integrity | 0.003 | 0.004 |
| Insufficient payload (model declined to judge) | 0.012 | 0.001 |
Machine scores (provisional)
The two teacher heads of the student model, read on this work. A score orders the frame for review; it never asserts a category, and the validation status ships verbatim with every row.
Baseline scores from an immature model (maturity gate not passed, 7 training rounds). Scores rank; they never assert a category.
score_only:v0-immature-baseline · verbatim from the scoring run: score_only means the number may rank works, and no category label ships from itClassification
machine, unvalidatedMachine predicted; a candidate call from one source (direct Gemma or distilled Codex), not a consensus.
How this classification was reached, model by model and score by score, is at the end of the page under "How this classification was reached".