Looking for the Twin Deficits in a Dollarized Oil-Exporting Economy
Published in SSRN preprint, 2025
Abstract. We study the effects of fiscal policy shocks on the trade balance and the real exchange rate in a dollarized, oil-exporting economy. Using data from Ecuador, we estimate a Bayesian Vector Autoregression (BVAR) model that properly characterizes the role of oil revenues in the transmission of fiscal policy. We simulate policy scenarios and test the twin deficits hypothesis. We find that fiscal deficits driven by increases in government consumption or tax cuts weaken the trade balance, providing evidence for the twin deficits hypothesis under certain policy configurations. Positive oil revenue shocks also lead to a deterioration of the non-oil trade balance. The real exchange rate appreciates in response to both government consumption and investment shocks, while it depreciates following an oil revenue shock. Since government spending and oil revenues often move together in oil-exporting countries, the divergence in their effects raises important challenges for policymakers seeking to maintain external balance.
Recommended citation: Camacho-Villagómez, F., & García-Albán, F. (2025). Looking for the Twin Deficits in a Dollarized Oil-Exporting Economy. Available at SSRN 5297795.
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