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Fiscal Deficits, Current Account Dynamics and Monetary Policy

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  • Giorgio Di Giorgio

    ()

  • Salvatore Nistic�

Abstract

This paper develops a stochastic two-country "perpetual youth" Dynamic New Keynesian model of the international business cycle with incomplete international financial markets and stationary net foreign assets. The model allows for a thorough analysis of the interaction of endogenous monetary policy with endogenous, non-balanced budget fiscal policy. We derive the dynamic and cyclical properties of fiscal deficit feedback rules under alternative monetary regimes, discuss the international transmission of productivity shocks, and the implications for net foreign assets and exchange rate dynamics. Our results imply that the degree of "fiscal discipline", i.e. the extent to which the fiscal rule responds to debt dynamics, is crucial for the dynamics of net foreign assets. We show that under low fiscal discipline (characterizing most industrialized countries, first and foremost the U.S.) temporary positive productivity shocks may result in highly persistent deteriorations of the external position in the medium run. Our results also suggest that any attempt by monetary policy alone to stabilize the dynamics of net foreign assets would induce excessive and costly fluctuations of the exchange rate.

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Bibliographic Info

Paper provided by Department of the Treasury, Ministry of the Economy and of Finance in its series Working Papers with number 8.

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Length: 43
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Handle: RePEc:itt:wpaper:wp2008-8

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Keywords: Fiscal Deficit; Current Account; DSGE Models; Monetary and Fiscal Policy.;

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References

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  1. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2003. "International risk-sharing and the transmission of productivity shocks," Working Papers 03-19, Federal Reserve Bank of Philadelphia.
  2. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1987. "International real business cycles," Working Papers 426, Federal Reserve Bank of Minneapolis.
  3. Christopher J. Erceg & Luca Guerrieri & Christopher Gust, 2005. "Expansionary fiscal shocks and the trade deficit," International Finance Discussion Papers 825, Board of Governors of the Federal Reserve System (U.S.).
  4. Beetsma, Roel & Jensen, Henrik, 2002. "Monetary and fiscal policy interactions in a micro-founded model of a monetary union," Working Paper Series 0166, European Central Bank.
  5. Giancarlo Marini & Alessandro Piergallini & Barbara Annicchiarico, 2004. "Monetary Policy and Fiscal Rules," CEIS Research Paper 50, Tor Vergata University, CEIS.
  6. Kollmann, Robert, 1998. "US trade balance dynamics: the role of fiscal policy and productivity shocks and of financial market linkages," Journal of International Money and Finance, Elsevier, vol. 17(4), pages 637-669, August.
  7. Cavallo, Michele & Ghironi, Fabio, 2002. "Net foreign assets and the exchange rate: Redux revived," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 1057-1097, July.
  8. Carlo Favero & Tommaso Monacelli, 2005. "Fiscal Policy Rules and Regime (In)Stability: Evidence from the U.S," Working Papers 282, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  9. Giorgio Di Giorgio & Salvatore Nistico, 2007. "Monetary Policy and Stock Prices in an Open Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(8), pages 1947-1985, December.
  10. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  11. Fagan, Gabriel & Henry, Jérôme & Mestre, Ricardo, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series 0042, European Central Bank.
  12. Christopher J. Erceg & Luca Guerrieri & Christopher Gust, 2005. "Expansionary Fiscal Shocks and the US Trade Deficit," International Finance, Wiley Blackwell, vol. 8(3), pages 363-397, December.
  13. Thomas Lubik & Frank Schorfheide, 2005. "A Bayesian Look at New Open Economy Macroeconomics," Economics Working Paper Archive 521, The Johns Hopkins University,Department of Economics.
  14. Paolo Manasse, 2006. "Procyclical Fiscal Policy," IMF Working Papers 06/27, International Monetary Fund.
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Cited by:
  1. Giorgio Di Giorgio & Salvatore Nistico', 2011. "Productivity Shocks, Stabilization Policies and the Dynamics of Net Foreign Assets," Working Papers CASMEF 1101, Dipartimento di Economia e Finanza, LUISS Guido Carli.
  2. Hohberger, Stefan & Herz, Bernhard, 2012. "Fiscal Policy, Monetary Regimes and Current Account Dynamics," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 66054, Verein für Socialpolitik / German Economic Association.

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