Analysis of twin deficits hypothesis in Indonesia and its impact on financial crisis

Abstract

This study aims to analyze the relationship between the current account and budget deficit (twin deficits hypothesis), measuring the account performance and other macroeconomic indicators in predicting the debt crisis in Indonesia. Furthermore, the data used for hypothesis was obtained from 2004q1-2017q4, followed by the application of the ARDL method, while values based on debt crisis were taken from the year 1981-2017, and indicators performance measurement required the use of Early Warning System (EWS) method, which was conducted through Quadratic Probability Score (QPS), and Global Squared Bias (GSB). The results indicate a longterm positive relationship between the current account and budget deficit (twin deficits), while the short-term studies reveal a negative association termed twin divergence, which occur on instances where a country has high savings rate. Furthermore, it was established that the current account deficit towards predicting the debt crisis in Indonesia was of a low performance, and the leading macroeconomic indicators include short-term debtforeign exchange reserves, the temporary debt-total external type, M2-foreign exchange reserves, inflation, IMF, and domestic credit-GDP. Therefore, the EWS model possesses 60% predictive abilities and an NTSR of 0.25, where the QPS value obtained was 0.373, and that of GSB was 0.005.

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