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Habit persistence and effectiveness of fiscal policy in an open economy

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  • Olivier Cardi

    ()
    (ERMES - Equipe de recherche sur les marches, l'emploi et la simulation - CNRS : UMR7017 - Université Panthéon-Assas - Paris II, Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X)

Abstract

An open economy version of the Baxter and King's [1993] model is constructed with habit formation to investigate the dynamic and steady-state effects of an expansionary budget policy. In line with empirical evidence, consumption is weakly responsive, investment is crowded out, the drop in savings drives the current account into deficit and government spending multipliers display small values. The sensitivity analysis shows that the effectiveness of the fiscal policy (1) decreases as habit persistence gets stronger, (2) increases with labor supply responsiveness, (3) falls with trade integration. Finally, we find that habit persistence weakens the connection between government spending multipliers and both the elasticity of labor supply and exports-to-GDP ratio.

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Bibliographic Info

Paper provided by HAL in its series Working Papers with number hal-00420138.

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Date of creation: 28 Sep 2009
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Handle: RePEc:hal:wpaper:hal-00420138

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Related research

Keywords: Investment; Current Account; Habit Formation; Expenditure Multiplier.;

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  1. Shi, Shouyong & Epstein, Larry G, 1993. "Habits and Time Preference," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(1), pages 61-84, February.
  2. Becker, Gary S & Murphy, Kevin M, 1988. "A Theory of Rational Addiction," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 675-700, August.
  3. Engelbert Dockner & Gustav Feichtinger, 1991. "On the optimality of limit cycles in dynamic economic systems," Journal of Economics, Springer, vol. 53(1), pages 31-50, February.
  4. Robert Kollmann, 2001. "The exchange rate in a dynamic-optimizing business cycle model with nominal rigidities: a quantitative investigation," ULB Institutional Repository 2013/7630, ULB -- Universite Libre de Bruxelles.
  5. Epstein, Larry G., 1987. "A simple dynamic general equilibrium model," Journal of Economic Theory, Elsevier, vol. 41(1), pages 68-95, February.
  6. Schubert, Stefan F & Turnovsky, Stephen J, 2002. "The Dynamics of Temporary Policies in a Small Open Economy," Review of International Economics, Wiley Blackwell, vol. 10(4), pages 604-22, November.
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