The The Twin Deficits Hypothesis: Revisiting the Link Between Budget Deficits and Trade Deficits in Tanzania

Abstract

The Twin Deficit Hypothesis has been extensively examined across various economic contexts, yet its applicability often depends on a country’s unique economic structure and dynamics. This study revisits the hypothesis in Tanzania, analyzing the relationship between the budget and trade deficits using quarterly time series data from 2005 to 2023. Employing a Granger Causality test within a multivariate Vector Error Correction Model, this research explores the direction of causality between the two deficits. The findings confirm a significant short and long-run relationship between the budget and trade deficits. Specifically, the results reveal a unidirectional short-run causality from the trade deficit to the budget deficit, aligning with the Current Account Targeting Hypothesis perspective of the Twin Deficit Hypothesis. Policies for effective exchange rate management, export diversification, and reducing import dependency are thus essential. These measures will lower external borrowing needs, enhance fiscal resilience, and support sustainable economic growth.