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Habit Formation and Fiscal Transmission in Open Economies

Listed author(s):
  • Olivier Cardi

    ()

    (ERMES - Equipe de recherche sur les marches, l'emploi et la simulation - CNRS - UP2 - Université Panthéon-Assas - M.E.N.E.S.R. - Ministère de l'Éducation nationale, de l’Enseignement supérieur et de la Recherche, Department of Economics, Ecole Polytechnique - Polytechnique - X - CNRS)

  • Gernot J. Muller

    ()

    (University of Bonn, Department of Economics - Bonn Universität - University of Bonn)

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. In a first step, we identify government spending shocks within a vector autoregression model. We find that i) government spending increases output and induces a simultaneous decline of investment and the current account, but does not affect consumption; ii) the responses of output and investment are smaller in more open economies, while current account deficits tend to be larger. We find the predictions of the model to be broadly in line with the evidence, once we allow for habit formation in consumption. Specifically, habits are crucial for government spending to induce a simultaneous decline in investment and the current account.

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Paper provided by HAL in its series Working Papers with number hal-00544484.

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Date of creation: 08 Dec 2010
Handle: RePEc:hal:wpaper:hal-00544484
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