The term twin deficits in economics refers to a country's domestic budget and foreign trade financial situation. The term became popular in the 1980s and 1990s in the United States when the country underwent a deficit in both areas. The effects of a twin deficit can be detrimental, as each deficit can feed off the other, causing a country's economic outlook to deteriorate.
A twin deficit occurs when a nation's government has a trade deficit -- also referred to as a current account deficit -- with other countries, as well as a budget deficit. A trade deficit happens when a nation imports more than it exports, meaning it buys from other countries and foreign companies more than it sells to them. A budget deficit occurs when a nation spends more on goods and services than it makes through taxes and other financial gains.
There are many factors that can cause a nation to incur a twin deficit. As with the United States in the early 1980s and early 2000s, a twin deficit can come into effect if government tax rates are reduced without corresponding cuts in government spending. When this occurs, a government will have a budget deficit due to the negative difference in government income and spending. This can lead to a twin deficit as a government will then borrow money from other nations, which leads to a trade deficit.
Twin Deficits in History
Prior to 1930, America enjoyed budget surpluses most years. However, after 1930 government spending began to outstrip income. By the second half of the 20th century, the trade surpluses the U.S. enjoyed in the mid-20th century diminished, and current account deficits became common. For instance, in 2001, when taxes were reduced without cuts in spending the U.S. went from a surplus to a deficit of 3.5 per cent of GDP by 2004. Simultaneously the trade deficit rose from 3.8 per cent of GDP in 2001 to 5.7 per cent in 2004.
Although some economists argue that budget deficits and current account deficits -- a twin deficit -- are tied together, others believe this is not the case. According to an article by George Washington University economics professor, Steven M. Suranovic, "There is no reason that 'twin' deficits need always appear together on these two national accounts. In fact, some countries will, at times, experience a deficit on one account and a surplus on the other (witness Japan in 2000)."
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- International Econ; The Twin Deficit Identity; Steven M. Suranovic; June 2004
- Federal Reserve Bank of San Francisco; Understanding the Twin Deficits: New Approaches, New Results; July 2005
- Finance-Lib: Definition of Twin Deficits
- U.S. House of Representatives; Joint Economic Committee Study; December 1998