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Journal of Economic Cooperation, 28, 4 (2007), 63-80 AN EMPIRICAL INVESTIGATION FOR THE TWIN DEFICITS HYPOTHESIS IN PAKISTAN Tahir Mukhtar, Muhammad Zakaria and Mehboob Ahmed∗ Pakistan constitutes a valuable case study for investigating the dynamics of persistently high rates of budget and current account deficits. In this paper an attempt has been made to empirically test the twin deficits hypothesis in Pakistan using quarterly time-series data for the period 1975 to 2005. The co-integration results indicate the existence of a long- run relationship between the deficits, while the Granger-causality test shows that bi-directional causality runs between the two variables. This finding casts doubt on the validity of the use of single-equation approach to analyze the twin deficits hypothesis. This implies that a more fruitful inquiry into the relationship between budget and current account deficits should be performed in the context of a simultaneous-equation model. 1. Introduction Like most developing countries a steady budget deficit in Pakistan is considered to be the primary cause of all major ills of the economy. It has varied between 2.4 to 8.8 percent during the last two and half decades. On the other hand, the current account deficit varied between 0.7 to 7.2 percent during the same period. It remains a controversial issue that variations in fiscal policy can lead to predictable developments in an open economy’s performance on current account. An important aspect of this issue concerns what is termed as the twin deficits hypothesis, according to which budget deficits and current account balances are very closely related so that reductions in the former are both necessary and sufficient