Twin Deficits: Apparition or Reality for Albania

Abstract

Twin deficits hypothesis (TDH), supported by the Keynesian approach, implies that an increase in a government’s budget deficit will deteriorate the country’s current account deficit. Numerous empir­ical studies have investigated this approach for in­dividual country case studies as well as for groups of countries in panel data analyses. Therefore, it is the purpose of this study to investigate the twin deficits hypothesis of Albania, a small developing economy in Eastern Europe. An econometric anal­ysis with quarterly data for the period 2008–2022 investigates this relationship, revealing political implications for fiscal policy and country trade im­balances. Empirical results show a unidirectional Granger cause between the budget balance and the current account balance. The vector error correction model finds evidence of the Keynesian twin hypoth­esis in the context of the Albanian economy. There is a long-run positive relationship between the budget deficit and the current account deficit, whereas the results do not hold in the short run. The short-term dynamics reveal a complex interplay where fiscal improvements deteriorate the current account. However, the adjustment factor error correction term stabilizes the short-run dynamics toward the long-run relationship, emphasizing the role of per­sistent coordination among fiscal disciplines and sustained trade imbalances.