Definition of Twin Deficits in Economics

The term twin deficits in economics refers to a country's domestic budget and foreign trade financial situation. The term became popular in the 1980s and 1990s in the United States when the country underwent a deficit in both areas. The effects of a twin deficit can be detrimental, as each deficit can feed off the other, causing a country's economic outlook to deteriorate.

A twin deficit occurs when a nation's government has both a trade deficit and a budget deficit. A trade deficit, also known as a current account deficit, happens when a nation imports more than it exports, buying more from other countries and foreign companies than it sells to them. A budget deficit occurs when a nation spends more on goods and services than it makes through taxes and other financial gains.

There are many factors that can cause a nation to incur a twin deficit. As with the U.S. in the early 1980s and early 2000s, a twin deficit can come into effect if government tax rates are reduced without corresponding cuts in government spending. When this occurs, a government will have a budget deficit due to the negative difference in government income and spending. This can lead to a twin deficit as a government will then borrow money from other nations, which leads to a trade deficit.

Prior to 1930, America enjoyed budget surpluses most years. However, after 1930 government spending began to outstrip income. By the second half of the 20th century, the trade surpluses the U.S. enjoyed in the mid-20th century diminished, and current account deficits became common. For instance, in 2001, when taxes were reduced without cuts in spending, the U.S. went from a surplus to a deficit of 3.5 percent of GDP by 2004. Simultaneously the trade deficit rose from 3.8 percent of GDP in 2001 to 5.7 percent in 2004.

Although some economists argue that twin deficits are tied together, others believe this is not always the case. A connection may be likely, but deficits can occur independently of each other. For example, in 2000, the U.S. had a budget surplus but also had a trade deficit. It is also possible for both accounts to show a surplus.