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Monetary Disinflation, Fiscal Expansion and the Current Account in an Interdependent World

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  • van der Ploeg, Frederick

Abstract

A two-country, intertemporal, perfect-foresight model with micro foundations, Cobb-Douglas preferences and technologies, floating exchange rates, uncovered interest parity,and nominal wage rigidities is formulated. The transient and steady-state effects of a joint and unilateral monetary disinflation and a fiscal expansion are analysed. The foreign repercussions of monetary and fiscal policy do not affect the home economy, so that the multipliers are the same as for a small open economy. Since Ricardian debt neutrality holds, the nominal interest rate is equal to the rate of time preference plus the discounted average of future, expected monetary growth rates, and is independent of fiscal policy and foreign policies. Also, monetary disinflation does not lead to overshooting of the nominal exchange rate. To give a non-trivial role to wealth effects, current-account dynamics and the nominal exchange rate, and to allow for more interesting international spillover effects, the model is extended to allow for finite lifetimes so that Ricardian debt neutrality no longer holds. The transient effects of tax-financed and debt-financed changes in monetary growth and government spending are discussed.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 366.

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Date of creation: Jan 1990
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Handle: RePEc:cpr:ceprdp:366

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Keywords: Current Account Wealth Dynamics; Finite Lives; International Interdependence; Two-Country Mundell-Fleming Model;

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  1. David Currie & Paul Levine, 1985. "Macroeconomic Policy Design In An Interdependent World," NBER Chapters, in: International Economic Policy Coordination, pages 228-273 National Bureau of Economic Research, Inc.
  2. Willem H. Buiter & Marcus Miller, 1991. "Real Exchange Rate Overshooting and the Output Cost of Bringing Down Inflation," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 239-277 National Bureau of Economic Research, Inc.
  3. Willem H. Buiter, 1984. "Saddlepoint Problems in Contifuous Time Rational Expectations Models: A General Method and Some Macroeconomic Ehamples," NBER Technical Working Papers 0020, National Bureau of Economic Research, Inc.
  4. Markink & A.J. & Van Der Ploeg.F, 1989. "Dynamic Policy Simulation Of Linear Models With Rational Expectations Of Future Events: A Computer Package," Papers 8906, Tilburg - Center for Economic Research.
  5. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  6. Rankin, Neil, 1987. "An Intertemporal Version of Mundell's Two-Country Flexible Exchange Rates Model with Disequilibrium Microfoundations: Is Policy Interdependence Inevitable?," CEPR Discussion Papers 185, C.E.P.R. Discussion Papers.
  7. van der Ploeg, Frederick, 1988. "Monetary and Fiscal Policy in Interdependent Economies with Capital Accumulation, Death and Population Growth," CEPR Discussion Papers 270, C.E.P.R. Discussion Papers.
  8. Westphal, Uwe, 1982. "'Real exchange rate overshooting and the output cost of bringing down inflation' by buiter and miller," European Economic Review, Elsevier, vol. 18(2), pages 129-130.
  9. Flood, Robert P., 1982. "'Real exchange rate overshooting and the output cost of bringing down inflation' by Buiter and Miller," European Economic Review, Elsevier, vol. 18(1), pages 125-127.
  10. Giovannini, Alberto, 1988. "The real exchange rate, the capital stock, and fiscal policy," European Economic Review, Elsevier, vol. 32(9), pages 1747-1767, November.
  11. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  12. Rogoff, Kenneth, 1985. "Can international monetary policy cooperation be counterproductive?," Journal of International Economics, Elsevier, vol. 18(3-4), pages 199-217, May.
  13. van der Ploeg, Frederick, 1987. "International Policy Coordination in Interdependent Monetary Economies," CEPR Discussion Papers 169, C.E.P.R. Discussion Papers.
  14. Dornbusch, Rudiger & Fischer, Stanley, 1980. "Exchange Rates and the Current Account," American Economic Review, American Economic Association, vol. 70(5), pages 960-71, December.
  15. Marcus Miller & Mark Salmon, 1985. "Policy Coordination And Dynamic Games," NBER Chapters, in: International Economic Policy Coordination, pages 184-227 National Bureau of Economic Research, Inc.
  16. Westphal, Uwe, 1982. "'Real exchange rate overshooting and the output cost of bringing down inflation' by Buiter and Miller," European Economic Review, Elsevier, vol. 18(1), pages 129-130.
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