The Relationship Between Fiscal Deficit and Current Account Deficit in the Case of the West African Monetary Zone: A Bivariate DSEM/RDSEM Approach

Abstract

For the past three decades, the relationship between fiscal deficit and current account deficit has been a highly contested issue in macroeconomic research and policy. The debate has centered on whether deterioration in the fiscal balance negatively affects current account balance. Against this background, various studies have been conducted to ascertain the nature of the relationship between these two key macroeconomic variables; however, conclusions have been mixed. This study contributes to ongoing discourse by adopting a contemporary modelling framework to explore the relationship between the variables within the scope of the West African Monetary Zone (WAMZ). The study is based on the dynamic structural equation model (DSEM) and the residual dynamic structural equation model (RDSEM) and utilized annual secondary data spanning from 1990 to 2019. The study concluded that there is no direct relationship between fiscal and current account deficits, thus opposing the twin deficit hypothesis. However, there is a contemporaneous relationship between the two variables when the autoregressive relationship in the residuals is significant. We therefore establish that worsening current account and fiscal deficits occur concurrently and are driven by the lagged relationship with other factors not explicitly captured in the model.