Budget Deficits and Rates of Interest in the World Economy
AbstractThis paper deals with the international transmission of the effects of budget deficits on world rates of interest and spending. The model assumes a two-country world within which capital markets are integrated, individuals behave rationally, and the behavior of individuals and governments are governed by temporal and intertemporal budget constraints. Adopting Olivier Blanchard's formulation it is assumed that due to the probability of finite life individuals behave as if their horizon was finite. This formulation generates asimple pattern of aggregate behavior of the two-country world, and it assures that the model is not subject to the Ricardian proposition according to which budget deficits do not matter. It is shown that, for a given time path of government spending, a budget deficit raises world rates of interest and domestic wealth while it lowers foreign wealth. Thus, the deficit is transmitted negatively to the rest of the world. The channel of transmission is the world capital market and the negative transmission results from the higher rate of interest. The paper proceeds with an analysis of balanced-budget changes in government spending. It is shown that a transitory current rise in government spending raises interest rates and lowers domestic and foreign wealth while an expected future rise in government spending lowers interest rates, reduces the value of domestic wealth and raises the value of foreign wealth. The effect of a permanent rise in government spending on the rate of interest depends on whether the domestic economy is a net saver or dissaver in the world economy, i.e., if it has acurrent account surplus or deficit. If the home country runs a current account surplus then a rise in government spending raises world interest rates and lowers domestic and foreign wealth, and if the home country runs a current account deficit then a permanent balanced-budget rise in government spending lowers interest rates and domestic wealth and raises foreign wealth.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1354.
Date of creation: Aug 1986
Date of revision:
Note: ITI IFM
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Razin, Assaf & Svensson, Lars E. O., 1983. "The current account and the optimal government debt," Journal of International Money and Finance, Elsevier, vol. 2(2), pages 215-224, August.
- Robert E. Lucas Jr. & Nancy L. Stokey, 1982.
"Optimal Fiscal and Monetary Policy in an Economy Without Capital,"
532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
- Blanchard, Olivier J, 1985.
"Debt, Deficits, and Finite Horizons,"
Journal of Political Economy,
University of Chicago Press, vol. 93(2), pages 223-47, April.
- Barro, Robert J, 1974.
"Are Government Bonds Net Wealth?,"
Journal of Political Economy,
University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
- Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467.
- Jacob A. Frenkel & Assaf Razin, 1986. "Fiscal Policies, Debt, and International Economic Interdependence," NBER Working Papers 1266, National Bureau of Economic Research, Inc.
- Finn Kydland & Edward C. Prescott, 1980. "A Competitive Theory of Fluctuations and the Feasibility and Desirability of Stabilization Policy," NBER Chapters, in: Rational Expectations and Economic Policy, pages 169-198 National Bureau of Economic Research, Inc.
- Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
- Buiter, Willem H, 1984.
"Fiscal Policy in Open, Interdependent Economies,"
CEPR Discussion Papers
28, C.E.P.R. Discussion Papers.
- Helpman, Elhanan & Razin, Assaf, 1987.
"Exchange Rate Management: Intertemporal Tradeoffs,"
American Economic Review,
American Economic Association, vol. 77(1), pages 107-23, March.
- Jacob A. Frenkel & Assaf Razin, 1984. "The International Transmission of Fiscal Expenditures and Budget Deficits in the World Economy," NBER Working Papers 1527, National Bureau of Economic Research, Inc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.