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Fiscal Shocks in a Two Sector Open Economy

  • Olivier Cardi

    ()

    (ERMES - Equipe de recherche sur les marches, l'emploi et la simulation - CNRS : UMR7017 - Université Paris II - Panthéon-Assas, Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X)

  • Romain Restout

    ()

    (UCL IRES - Institut de recherches économiques et sociales - Université Catholique de Louvain (UCL) - Belgique)

We use a two-sector neoclassical open economy model with traded and non-traded goods to investigate both the aggregate and the sectoral e®ects of temporary ¯scal shocks. One central ¯nding is that both sectoral capital intensities and labor supply elasticity matter in determining the response of key economic variables. In particular, the model can produce a drop in investment and in the current account, in line with em- pirical evidence, only if the traded sector is more capital intensive than the non-traded sector, and labor is supplied elastically. Irrespective of sectoral capital intensities, a ¯s- cal shock raises the relative size of the non-traded sector substantially in the short-run. Additionally, allowing for the markup to depend on the number of competitors, the two-sector model can produce the real exchange rate depreciation found in the data. Finally, markup variations triggered by ¯rm entry modify substantially the response of the real wage and the sectoral composition of GDP in the short-run.

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Date of creation: Feb 2011
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Handle: RePEc:hal:wpaper:halshs-00812166
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