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A Party without a Hangover?on the Effects of U.S. Government Deficits

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Author Info

  • Douglas Laxton
  • Michael Kumhof

Abstract

This paper develops a 2-country New Keynesian overlapping generations model suitable for the joint evaluation of monetary and fiscal policies. We show that a permanent increase in U.S. government deficits raises the world real interest rate and significantly increases U.S. current account deficits, especially in the medium- to long-run. A simultaneous increase in non-U.S. savings lowers the world real interest rate and further increases U.S. current account deficits. We show that conventional infinite horizon models are ill-equipped to deal with issues that involve permanent changes in public or private sector savings rates.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/202.

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Length: 38
Date of creation: 01 Aug 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/202

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Keywords: Budget deficits; Public debt; Economic models; current account; government debt; fiscal policy; current account deficit; government spending; current account deficits; fiscal deficits; account deficits; government deficits; fiscal policies; aggregate demand; fiscal consolidation; spending cuts; current account balances; government deficit; budget constraint; tax rates; tax burden; domestic currency; fiscal expansion; debt obligations; fiscal issues; taxation; fiscal multipliers; public spending; fiscal data; tax income; balance of payments; fiscal deficit; fiscal shocks; reserve bank; central banks; fiscal balances; increase in consumption; domestic savings; expenditure cuts; tax policy; government budget; current account balance; composition of public spending; international lending; debt stock; government expenditures; expansionary fiscal; government budget constraint; tax revenue; fiscal surpluses; fiscal policy targets; net debtors; fiscal policy on consumption; tax payments; domestic financial markets;

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References

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  1. Aschauer, David Alan, 1989. "Does public capital crowd out private capital?," Journal of Monetary Economics, Elsevier, vol. 24(2), pages 171-188, September.
  2. Obstfeld, Maurice & Rogoff, Kenneth S., 1995. "Exchange Rate Dynamics Redux," Scholarly Articles 12491026, Harvard University Department of Economics.
  3. Menzie D. Chinn & Jaewoo Lee, 2005. "Three Current Account Balances: A "Semi-Structuralist" Interpretation," NBER Working Papers 11853, National Bureau of Economic Research, Inc.
  4. Philip R. Lane & Giovanni Ganelli, 2002. "Dynamic General Equilibrium Analysis: The Open Economy Dimension," Trinity Economics Papers 200212, Trinity College Dublin, Department of Economics.
  5. Menzie D. Chinn & Hiro Ito, 2005. "Current Account Balances, Financial Development and Institutions: Assaying the World "Savings Glut"," NBER Working Papers 11761, National Bureau of Economic Research, Inc.
  6. Christophe Kamps, 2004. "New Estimates of Government Net Capital Stocks for 22 OECD Countries 1960-2001," IMF Working Papers 04/67, International Monetary Fund.
  7. Buiter, Willem H, 1981. "Time Preference and International Lending and Borrowing in an Overlapping-Generations Model," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 769-97, August.
  8. Galí, Jordi & Vallés, Javier & Wolman, Alexander L., 2003. "Understanding the effects of government spending on consumption," CFS Working Paper Series 2004/23, Center for Financial Studies (CFS).
  9. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc.
  10. Jordi Gali & David López-Salido & Javier Valles, 2004. "Understanding the effects of government spending on consumption," International Finance Discussion Papers 805, Board of Governors of the Federal Reserve System (U.S.).
  11. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April.
  12. Ireland, Peter N., 2001. "Sticky-price models of the business cycle: Specification and stability," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 3-18, February.
  13. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  14. Ganelli, G., 2000. "Useful Government Spending, Direct Crowding Out and Fiscal Policy Interdependence," The Warwick Economics Research Paper Series (TWERPS) 547, University of Warwick, Department of Economics.
  15. Andrea Ferrero, 2006. "Demographic Trends, Fiscal Policy and Trade Deficits," 2006 Meeting Papers 444, Society for Economic Dynamics.
  16. Eric M. Engen & R. Glenn Hubbard, 2004. "Federal Government Debt and Interest Rates," NBER Working Papers 10681, National Bureau of Economic Research, Inc.
  17. Hamid Faruqee & Douglas Laxton & Dirk Muir & Paolo Pesenti, 2005. "Smooth Landing or Crash? Model-Based Scenarios of Global Current Account Rebalancing," NBER Working Papers 11583, National Bureau of Economic Research, Inc.
  18. Ganelli, Giovanni, 2005. "The new open economy macroeconomics of government debt," Journal of International Economics, Elsevier, vol. 65(1), pages 167-184, January.
  19. Caselli, Paola, 2001. "Fiscal consolidation under fixed exchange rates," European Economic Review, Elsevier, vol. 45(3), pages 425-450, March.
  20. Weber, Christian E., 2002. "Intertemporal non-separability and "rule of thumb" consumption," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 293-308, March.
  21. Bayoumi, Tamim & Sgherri, Silvia, 2006. "Mr Ricardo's Great Adventure: Estimating Fiscal Multipliers in a Truly Intertemporal Model," CEPR Discussion Papers 5839, C.E.P.R. Discussion Papers.
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