ABSTRACT
Analysts and politician have shown concern over the state of the external imbalances in the past two decades or so. Most observers consider large external deficit to have been the cause of macroeconomic imbalances. In attempt to study the external imbalances numerous researchers had explored the possible link between internal deficit and external deficit. The so-called twin deficits hypothesis erupted during the ‘Reagan fiscal experiment’ in the 1980s which marked a period of strong appreciation of the dollar with unusual shift hike in external deficit not in favor of the United States is an example in history.1 This close connection between external and internal deficits, however, is not unique for the United States. In Europe, Germany and Sweden faced similar problems emerged in the early part of the 1990s where the rise in the internal deficit was accompanied by a real appreciation of their national currencies which adversely affect the current accounts (see Ibrahim and Kumah, 1996). Developing countries are no exception, most have also experienced problem with external debts in early 1980s. Several authors have documented that the unsustainable internal deficit during these periods has widens the external deficit. Indeed, authors like Laney (1984) found that the relationship between these two variables is much stronger for the developing countries. The emergence of internal-external deficits phenomena in many countries has drawn increasing attention to the problem of ‘twin deficits’.
