Causality between current account and budget deficits in Kenya

Abstract

The theoretical framework of National Income Identity in economic theory shows that there exist a relationship between the budget and the current account deficit. In this paper, we provide an exhaustive characterization of the empirical long run equilibrium linkage and causality between the current account deficit and budget deficit using Vector Autoregressive Model (VAR) with extension of Vector Error Correction Model and by adopting Johansen Maximum Likelihood Estimation Cointegration methodology, which also involved unit root test and the use of Granger test to investigate the causality between the two deficits. The results indicate that both the current account and budget deficits are integrated of order one and there exists along run relationship between them, on the other hand causality runs from current account deficit to Budget deficit. The econometric analysis suggests that …