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Do Tax Cuts Generate Twin Deficits? A Multi-Country Analysis

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  • Martin Boileau
  • Michel Normandin

Abstract

We study the effects of tax shocks on the budget and external deficits for 16 industrialized countries over the post-1975 period. Our structural approach is based on a tractable small open-economy model where a tax cut innovation generates a budget deficit. In turn, the budget deficit affects the external deficit by two distinct channels. The demographic channel works through the overlapping-generation structure of the model. The forecasting channel works through the dynamic structure of the model. Our empirical analysis documents that tax shocks generate significant positive comovements between the budget and external deficits. We also find that both the demographic and forecasting channels are important to explain the comovements.

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Bibliographic Info

Paper provided by CIRPEE in its series Cahiers de recherche with number 0832.

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Date of creation: 2008
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Handle: RePEc:lvl:lacicr:0832

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Keywords: Budget Deficit; External Deficit; Fiscal Policy; Overlapping Generations;

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  1. Leonardo Bartolini & Amartya Lahiri, 2006. "Twin deficits, twenty years later," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 12(Oct).
  2. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April.
  3. Lane, Philip & Milesi-Ferretti, Gian Maria, . "External Wealth of Nations," Instructional Stata datasets for econometrics extwealth, Boston College Department of Economics.
  4. Boileau, Martin & Normandin, Michel, 2002. "Aggregate employment, real business cycles, and superior information," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 495-520, April.
  5. Normandin, Michel, 1999. "Budget deficit persistence and the twin deficits hypothesis," Journal of International Economics, Elsevier, vol. 49(1), pages 171-193, October.
  6. Corsetti, Giancarlo & Müller, Gernot, 2007. "Twin Deficits, Openness and the Business Cycle," CEPR Discussion Papers 6492, C.E.P.R. Discussion Papers.
  7. Bussière, Matthieu & Fratzscher, Marcel & Müller, Gernot J., 2010. "Productivity shocks, budget deficits and the current account," Journal of International Money and Finance, Elsevier, vol. 29(8), pages 1562-1579, December.
  8. Giancarlo Corsetti & Gernot J. Müller, 2006. "Twin deficits: squaring theory, evidence and common sense," Economic Policy, CEPR & CES & MSH, vol. 21(48), pages 597-638, October.
  9. Roel Beetsma & Massimo Giuliodori & Franc Klaassen, 2008. "The Effects of Public Spending Shocks on Trade Balances and Budget Deficits in the European Union," Journal of the European Economic Association, MIT Press, vol. 6(2-3), pages 414-423, 04-05.
  10. Gali, Jordi, 1990. "Finite horizons, life-cycle savings, and time-series evidence on consumption," Journal of Monetary Economics, Elsevier, vol. 26(3), pages 433-452, December.
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