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Habits, costly investment, and current account dynamics

  • Ikeda, Shinsuke
  • Gombi, Ichiro

Using a small country model with habit-forming consumers and costly investment, we analyze equilibrium dynamics of the economy and derive empirical and welfare implications. The model can mimic some stylized facts: (i) a temporary increase in fiscal spending always deteriorates the current account whereas a permanent increase in fiscal spending may have a weaker effect; (ii) permanent productivity shocks deteriorate the current account; and (iii) savings and investment tend to co-move upon macroeconomic shocks. Strong habit persistence causes sluggishness in welfare dynamics. Consequently, a beneficial fiscal policy may have a harmful hangover effect on the future welfare.

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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 49 (1999)
Issue (Month): 2 (December)
Pages: 363-384

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Handle: RePEc:eee:inecon:v:49:y:1999:i:2:p:363-384
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