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Current Account and Budget Deficits in an Intertemporal Model of Consumption and Taxation Smoothing. A Solution to the "Feldstein-Horioka Puzzle"?

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  • Nouriel Roubini

Abstract

This paper presents an infinite horizon model of consumption and taxation " smoothing" that implies a simple relation between current accounts, budget deficits, investment rates and transitory output shocks. It is argued that such a model could explain the "Feldstein-Horioka puzzle" of the apparent lack of international capital mobility. Traditional regressions of the savings rate on the investment rate, as performed in the literature, are shown to be incorrect tests of the hypothesis of capital mobility because they do not control for the independent role of budget deficits and temporary output shocks in the current account and savings equations. Empirical tests of the model for a sample of 18 OECD countries present good evidence that international capital markets are widely integrated and that the "Feldstein-Horioka puzzle" might be explained by the important role of fiscal deficits in the determination of the current account and the saving behavior.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2773.

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Date of creation: Nov 1988
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Handle: RePEc:nbr:nberwo:2773

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  1. Lawrence H. Summers, 1988. "Tax Policy and International Competitiveness," NBER Chapters, in: International Aspects of Fiscal Policies, pages 349-386 National Bureau of Economic Research, Inc.
  2. Willem H. Buiter, 1979. "Time Preference and International Lending and Borrowing in an Overlapping-Generations Model," NBER Working Papers 0352, National Bureau of Economic Research, Inc.
  3. Maurice Obstfeld, 1986. "How Integrated are World Capital Markets? Some New Tests," NBER Working Papers 2075, National Bureau of Economic Research, Inc.
  4. Nouriel Roubini & Jeffrey Sachs, 1988. "Political and Economic Determinants of Budget Deficits in the IndustrialDemocracies," NBER Working Papers 2682, National Bureau of Economic Research, Inc.
  5. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 90(358), pages 314-29, June.
  6. Persson, Torsten & Svensson, Lars E O, 1985. "Current Account Dynamics and the Terms of Trade: Harberger-Laursen-Metzler Two Generations Later," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 93(1), pages 43-65, February.
  7. Razin, Assaf & Svensson, Lars E. O., 1983. "The current account and the optimal government debt," Journal of International Money and Finance, Elsevier, Elsevier, vol. 2(2), pages 215-224, August.
  8. Stockman, Alan C. & Svensson, Lars E. O., 1987. "Capital flows, investment, and exchange rates," Journal of Monetary Economics, Elsevier, Elsevier, vol. 19(2), pages 171-201, March.
  9. Campbell, John & Mankiw, Gregory, 1987. "Are Output Fluctuations Transitory?," Scholarly Articles 3122545, Harvard University Department of Economics.
  10. Bruno, Michael, 1976. "The Two-Sector Open Economy and the Real Exchange Rate," American Economic Review, American Economic Association, American Economic Association, vol. 66(4), pages 566-77, September.
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  12. Gerard Caprio & David H. Howard, 1983. "Domestic saving, current accounts, and international capital mobility," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 244, Board of Governors of the Federal Reserve System (U.S.).
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  14. Tobin, James, 1983. "'Domestic saving and international capital movements in the long run and the short run' by M. Feldstein," European Economic Review, Elsevier, Elsevier, vol. 21(1-2), pages 153-156.
  15. Martin Feldstein, 1982. "Domestic Saving and International Capital Movements in the Long Run and the Short Run," NBER Working Papers 0947, National Bureau of Economic Research, Inc.
  16. David Alan Aschauer, 1986. "The equilibrium approach to fiscal policy," Staff Memoranda, Federal Reserve Bank of Chicago 86-2, Federal Reserve Bank of Chicago.
  17. Frenkel, Jacob A & Razin, Assaf, 1986. "Fiscal Policies in the World Economy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 94(3), pages 564-94, June.
  18. Ahmed, Shaghil, 1986. "Temporary and permanent government spending in an open economy: Some evidence for the United Kingdom," Journal of Monetary Economics, Elsevier, Elsevier, vol. 17(2), pages 197-224, March.
  19. Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, Elsevier, vol. 10(2), pages 139-162.
  20. Svensson, Lars E O & Razin, Assaf, 1983. "The Terms of Trade and the Current Account: The Harberger-Laursen-Metzler Effect," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(1), pages 97-125, February.
  21. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, Elsevier, vol. 10(3), pages 335-359.
  22. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(5), pages 893-920, October.
  23. Anderson, James E. & Young, Leslie, 1992. "Optimal taxation and debt in an open economy," Journal of Public Economics, Elsevier, Elsevier, vol. 47(1), pages 27-57, February.
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