Where T stands for taxes collected by the government, Government saving is defined as difference between
government revenue from tax (T) and government expenditures which consists of government purchases, G, and
government transfers, Tr; mathematically,
Sg = T – G –Tr (6)
By using the definition of national saving and using equation (3), we have:
S = Sp + Sg = (Y – T – C) + (T – G - Tr) = I + CA (7)
We can rewrite identity (7) in a form, which is useful for analyzing the effects of government saving decisions on
an open economy.
Sp = I + CA – Sg = I + CA – (T – G - Tr) (8)
Equation (8) states that a country’s private saving can take three forms: investment in domestic capital, purchases
of wealth from foreigners (CA), and purchases of the domestic government’s newly issued debt (G +Tr –T).
Rearranging equation (8), we have:
CA = (I – Sp) + BB (9)
Where BB is budget balance and equals to (T - G - Tr). BB measures the extent to which the government is
borrowing to finance its expenditures.
Looking at the macroeconomic identity (equation 9), we can see that two extreme cases are possible. If we assume
that the difference between private savings (Sp) and investment (I) is stable over time, the fluctuations in the
public sector balance will be fully translated to current account and vice versa. Therefore, the twin deficit
hypothesis will hold. The second extreme case is the Ricardian Equivalence Hypothesis (REH), in which if the
government budget deficit increases then people respond by increasing their private saving, accordingly no effect
will appear on current account (Thomas and Abderrezak, 1988).
4. Data and Statistical Description
In this section we proceed with the empirical investigation of the twin deficits hypothesis for Kuwait data over the
quarterly sample period (1993:4-2010:4) which obtained from International Financial Statistics (IFS) and the
Central Bank of Kuwait (www.cbk.gov.kw).