Twin Deficits Hypothesis
The twin deficits hypothesis holds that a larger government budget deficit tends to widen the current-account (trade) deficit through interest rates and the exchange rate.
When the government runs a budget deficit, increased borrowing raises domestic interest rates, attracting foreign capital inflows that appreciate the currency; the stronger currency makes exports dearer and imports cheaper, widening the trade deficit. The national-accounts identity (S − I) + (T − G) = NX shows the linkage: a fall in public saving, all else equal, must be offset by lower net exports or higher foreign borrowing. Critics note the link is empirically loose and can be broken by Ricardian equivalence or offsetting changes in private saving. It is a classic explanation for the co-movement of U.S. budget and trade deficits in the 1980s.