Structural breaks and the twin deficits hypothesis

Recent theoretical and empirical analyses of the relation between the current account and the government budget balance suggest that the “twin deficits” relation is subject to structural changes. Most previous empirical analyses impose the change point without resorting to econometric testing. In this paper we utilize time series data to evaluate the impact of structural breaks on the long- and short-run relation between current account, government balance and investment in 22 OECD countries. We found that when allowing for the possible existence of structural breaks of unknown date, the data reveal more clearly the long-run relation between the current account and its determinants. Moreover, the empirical results show that the degree of financial integration is generally increasing in most OECD countries, including the leading non-EU economies. This contrasts some recent evidence on the persistence of the so-called Feldstein–Horioka puzzle.