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Monetary Disinflation, Fiscal Expansion and the Current Account in an Interdependent World

  • van der Ploeg, Frederick

A two-country, intertemporal, perfect-foresight model with micro foundations, Cobb-Douglas preferences and technologies, floating exchange rates, uncovered interest parity,and nominal wage rigidities is formulated. The transient and steady-state effects of a joint and unilateral monetary disinflation and a fiscal expansion are analysed. The foreign repercussions of monetary and fiscal policy do not affect the home economy, so that the multipliers are the same as for a small open economy. Since Ricardian debt neutrality holds, the nominal interest rate is equal to the rate of time preference plus the discounted average of future, expected monetary growth rates, and is independent of fiscal policy and foreign policies. Also, monetary disinflation does not lead to overshooting of the nominal exchange rate. To give a non-trivial role to wealth effects, current-account dynamics and the nominal exchange rate, and to allow for more interesting international spillover effects, the model is extended to allow for finite lifetimes so that Ricardian debt neutrality no longer holds. The transient effects of tax-financed and debt-financed changes in monetary growth and government spending are discussed.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 366.

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Date of creation: Jan 1990
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Handle: RePEc:cpr:ceprdp:366
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  1. Rogoff, Kenneth, 1985. "Can international monetary policy cooperation be counterproductive?," Journal of International Economics, Elsevier, vol. 18(3-4), pages 199-217, May.
  2. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  3. Giovannini, Alberto, 1988. "The real exchange rate, the capital stock, and fiscal policy," European Economic Review, Elsevier, vol. 32(9), pages 1747-1767, November.
  4. Buiter, Willem H. & Miller, Marcus, 1982. "Real exchange rate overshooting and the output cost of bringing down inflation," European Economic Review, Elsevier, vol. 18(1), pages 85-123.
  5. Markink & A.J. & Van Der Ploeg.F, 1989. "Dynamic Policy Simulation Of Linear Models With Rational Expectations Of Future Events: A Computer Package," Papers 8906, Tilburg - Center for Economic Research.
  6. Maurice Obstfeld, 1988. "Fiscal Deficits and Relative Prices in a Growing World Economy," NBER Working Papers 2725, National Bureau of Economic Research, Inc.
  7. David Currie & Paul Levine, 1985. "Macroeconomic Policy Design in an Interdependent World," NBER Chapters, in: International Economic Policy Coordination, pages 228-273 National Bureau of Economic Research, Inc.
  8. Turnovsky, Stephen J, 1986. "Monetary and Fiscal Policy under Perfect Foresight: A Symmetric Two-country Analysis," Economica, London School of Economics and Political Science, vol. 53(210), pages 139-57, May.
  9. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  10. Dornbusch, Rudiger & Fischer, Stanley, 1980. "Exchange Rates and the Current Account," American Economic Review, American Economic Association, vol. 70(5), pages 960-71, December.
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