Twin deficit and capital mobility under different monetary policy regimes
University of Lethbridge. Faculty of Arts and Science
Lethbridge, Alta : University of Lethbridge, Dept. of Economics
The relationship between the government budget and the current account deficits has been explained to depend on the degree of capital mobility, exchange rate regimes and other important factors. One factor that has not received much attention is how different monetary policy regimes may affect the relationship through their effects on the transmission mechanism between the two deficits. We consider the theoretical bases for analyzing the twin deficit hypothesis within an IS-MP model as an alternative to the conventional IS-LM-BP model and the predictions of the models are tested using empirical data. Using, Canada, the U.K. and the U.S., we found that rules-based monetary policy, particularly inflation targeting, improves capital mobility and changes the relationship between the government budget deficit and the current account deficit. The changes however, we identify to be dependent on how well the policy rule is able to control the effects of inflation expectations.
budget deficit , capital mobility , current account balance , inflation targeting , monetary policy , twin deficit hypothesis