LONG-RUN LINKAGE BETWEEN BUDGET DEFICIT AND TRADE DEFICIT IN LEBANON: RESULTS FROM THE UECM AND BOUNDS TESTS

Abstract

This paper examines the linkage between budget deficit and trade deficit for Lebanon during the period from 1975 to 2003. The purpose is to test the validity of the Keynesian proposition and the Ricardian equivalence in the case of Lebanon. A robust econometric framework called the unrestricted error correction model (UECM) and a cointegration test called the bounds test are used to examine whether budget deficit and trade deficit are cointegrated. The Granger causality test shows that causality runs from trade deficit to budget deficit and the relationship is positive and statistically significant. The empirical analysis in this paper partially supports the Keynesian view that there is a linkage between trade deficit and budget deficit but the direction of causality is reversed which is consistent with many other empirical studies. The result suggests that any policy measures to reduce the trade deficit in Lebanon could well assist in reducing the Lebanese budget deficit.

JEL classification: E62

Key words: Trade deficit, Cointegration, Lebanon