What Are Twin Deficits?
Economies that have both a fiscal deficit and a current account deficit are often said to have “twin deficits.” This means that government revenues are lower than the government’s expenses and the price of the country’s imports is greater than the income from its exports.
The United States has experienced twin deficits since the 1980s. The opposite scenario is a fiscal surplus and a current account surplus. This is generally viewed as preferable but much depends on the circumstances. China is often cited as an example of a nation that has enjoyed long-term fiscal and current account surpluses.
Key Takeaways
- Twin deficits in the U.S. usually refer to the nation’s fiscal and current account deficits.
- A fiscal deficit is a budget shortfall.
- A current account deficit means that a country is sending more money overseas for goods and services than it’s receiving.
- Many economists argue that the twin deficits are correlated but there’s no clear consensus on the issue.
The First Twin: Fiscal Deficit
A fiscal deficit or budget deficit occurs when a nation’s spending exceeds its revenues. The U.S. has run fiscal deficits every year since 2002.
A fiscal deficit doesn’t sound like a good thing but Keynesian economists argue that deficits aren’t necessarily harmful. Deficit spending can be a useful tool for jump-starting a stalled economy. Deficit spending on infrastructure and other big projects can contribute to aggregate demand when a nation is experiencing a recession. Workers hired for the projects spend their money, fueling the economy and boosting corporate profits.
Governments often fund fiscal deficits by issuing bonds. Investors buy the bonds, effectively loaning money to the government and earning interest on the loan. Investors’ principal is returned when the government repays its debts. Making a loan to a stable government is often viewed as a safe investment. Governments can generally be counted on to repay their debts because their ability to levy taxes gives them a reliable way to generate revenue.
The Second Twin: Current Account Deficit
A current account is a measure of a country’s trade and financial transactions with the rest of the world. This includes the difference between the value of its exports of goods and services and its imports as well as net payments on foreign investments and other transfers from abroad.
A country with a current account deficit is spending more overseas than it’s taking in. Again, intuition suggests this isn’t good. Those countries must continually borrow money to make up the shortfall and interest must be paid to service that debt. This can leave smaller, developing countries exposed to international investors and markets.
Important
A sustained deficit of exports versus imports can indicate that a country has lost its competitiveness or it can reflect an unsustainably low savings rate among the deficit-running country’s people.
The truth about current accounts isn’t that simple. A current account deficit can reflect that a country is an attractive destination for investment as is the case with the U.S. Consider that advanced economies such as the U.S. often run current account deficits. Developing economies typically run surpluses.
Twin Deficit Hypothesis
Some economists believe that a large budget deficit is correlated to a large current account deficit. This macroeconomic theory is known as the twin deficit hypothesis. The logic behind the theory is that government tax cuts that reduce revenue and increase the deficit will result in increased consumption as taxpayers spend their new-found money. The increased spending reduces the national savings rate, causing the nation to increase the amount it borrows from abroad.
A nation often turns to foreign investors as a source of borrowing when it runs out of money to fund its fiscal spending. Its citizens are often using borrowed money to purchase imported goods at the same time the nation is borrowing from abroad. Economic data sometimes supports the twin deficit hypothesis but at other times it does not.
Which Country Has the Highest Budget Deficit?
Japan had the highest level of public debt with a total deficit of 216.2% of the country’s GDP as of 2022, according to World Bank data. Data is unavailable or out of date for many countries.
Which Country Has the Highest Trade Deficit?
World Bank data indicates that Equatorial Guinea had the highest trade deficit as of 1996. The country’s account balance showed a deficit of -148% of the country’s GDP. Again, many countries have not reported more recent figures.
Why Is a Trade Deficit Bad?
A trade deficit means that a country is importing more goods than it exports. This results in a high demand for foreign currency and a low demand for domestic currency. A consistent trade deficit can be harmful to the domestic economy because local producers don’t have enough demand for their goods.
The Bottom Line
Twin deficits refer to a combined shortfall between a country’s government revenues and its export income. Some economists believe that these deficits are related because low tax revenues can result in increased borrowing from abroad.
The United States consistently runs both budget deficits and trade deficits. Some economists predict that this may lead to unexpected disruptions.