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A Party without a Hangover? On the Effects of U.S. Government Deficits

  • Douglas Laxton
  • Michael Kumhof

This paper develops a 2-country New Keynesian overlapping generations model suitable for the joint evaluation of monetary and fiscal policies. We show that a permanent increase in U.S. government deficits raises the world real interest rate and significantly increases U.S. current account deficits, especially in the medium- to long-run. A simultaneous increase in non-U.S. savings lowers the world real interest rate and further increases U.S. current account deficits. We show that conventional infinite horizon models are ill-equipped to deal with issues that involve permanent changes in public or private sector savings rates.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/202.

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Length: 38
Date of creation: 01 Aug 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/202
Contact details of provider: Postal: International Monetary Fund, Washington, DC USA
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  1. Menzie D. Chinn & Hiro Ito, 2005. "Current Account Balances, Financial Development and Institutions: Assaying the World "Savings Glut"," NBER Working Papers 11761, National Bureau of Economic Research, Inc.
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  3. Ganelli, Giovanni, 2003. "The New Open Economy Macroeconomics of Government Debt," Royal Economic Society Annual Conference 2003 83, Royal Economic Society.
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  8. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1329-1368, November.
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  12. Christopher J. Erceg & Luca Guerrieri & Christopher Gust, 2006. "SIGMA: A New Open Economy Model for Policy Analysis," International Journal of Central Banking, International Journal of Central Banking, vol. 2(1), March.
  13. David Aschauer, 1988. "Does public capital crowd out private capital?," Staff Memoranda 88-10, Federal Reserve Bank of Chicago.
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  17. Andrea Ferrero, 2006. "Demographic Trends, Fiscal Policy and Trade Deficits," 2006 Meeting Papers 444, Society for Economic Dynamics.
  18. Galí, Jordi & Vallés, Javier & Wolman, Alexander L., 2003. "Understanding the effects of government spending on consumption," CFS Working Paper Series 2004/23, Center for Financial Studies (CFS).
  19. Bayoumi, Tamim & Sgherri, Silvia, 2006. "Mr Ricardo's Great Adventure: Estimating Fiscal Multipliers in a Truly Intertemporal Model," CEPR Discussion Papers 5839, C.E.P.R. Discussion Papers.
  20. Weber, Christian E., 2002. "Intertemporal non-separability and "rule of thumb" consumption," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 293-308, March.
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  23. Caselli, Paola, 2001. "Fiscal consolidation under fixed exchange rates," European Economic Review, Elsevier, vol. 45(3), pages 425-450, March.
  24. R. Glenn Hubbard & Eric M. Engen, 2004. "Federal Government Debt and Interest Rates," Working Papers 50018, American Enterprise Institute.
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