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Habit formation and fiscal transmission in open economies

  • Cardi, Olivier
  • Müller, Gernot J.

In this paper we analyze the ability of an open economy version of the neoclassical model to account for the time-series evidence on fiscal policy transmission. Revisiting the evidence, we find that i) government spending raises output, while inducing a simultaneous decline of investment and the current account and ii) the responses of output and investment are more muted in more open economies while current account deficits tend to be larger. Turning to the model, we explore the role of habit formation for fiscal policy transmission. Specifically, we show that the model can account for the evidence if consumption behavior is characterized by habit formation and the terms of trade adjust endogenously.

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

Volume (Year): 85 (2011)
Issue (Month): 2 ()
Pages: 256-267

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Handle: RePEc:eee:inecon:v:85:y:2011:i:2:p:256-267
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505552

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  1. Andrew Mountford & Harald Uhlig, 2008. "What are the Effects of Fiscal Policy Shocks?," NBER Working Papers 14551, National Bureau of Economic Research, Inc.
  2. Stephen J. Turnovsky & Partha Sen, 1990. "Fiscal Policy, Capital Accumulation, and Debt in an Open Economy," NBER Working Papers 3489, National Bureau of Economic Research, Inc.
  3. Domeij, David & Floden, Martin, 2001. "The labor-supply elasticity and borrowing constraints: Why estimates are biased," SSE/EFI Working Paper Series in Economics and Finance 480, Stockholm School of Economics.
  4. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1994. "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, American Economic Association, vol. 84(1), pages 84-103, March.
  5. Soyoung Kim & Nouriel Roubini, 2004. "Twin Deficit or Twin Divergence? Fiscal Policy, Current Account, and Real Exchange Rate in the US," Econometric Society 2004 North American Winter Meetings 271, Econometric Society.
  6. Craig Burnside & Martin Eichenbaum & Jonas Fisher, 2003. "Fiscal Shocks and Their Consequences," NBER Working Papers 9772, National Bureau of Economic Research, Inc.
  7. 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.
  8. Jody Overland & Christopher D. Carroll & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June.
  9. Enders, Zeno & Müller, Gernot J. & Scholl, Almuth, 2011. "How do fiscal and technology shocks affect real exchange rates?: New evidence for the United States," Journal of International Economics, Elsevier, vol. 83(1), pages 53-69, January.
  10. Bayoumi, Tamim, 1998. "Estimating Trade Equations from Aggregate Bilateral Data," CEPR Discussion Papers 1970, C.E.P.R. Discussion Papers.
  11. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-34, June.
  12. Karayal in, Cem, 2003. "Habit Formation And Government Spending In A Small Open Economy," Macroeconomic Dynamics, Cambridge University Press, vol. 7(03), pages 407-423, June.
  13. Karayalcin, Cem, 1999. "Temporary and permanent government spending in a small open economy," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 125-141, February.
  14. Sommer Martin, 2007. "Habit Formation and Aggregate Consumption Dynamics," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-25, August.
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