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The Effects of Government Spending Under Limited Capital Mobility


  • Wenyi Shen
  • Susan S. Yang


This paper studies the effects of government spending under limited international capital mobility, as featured by most developing countries. While external financing of government debt mitigates the crowding-out effect, it generates real appreciation, which contracts traded output and lowers the fiscal multiplier in the short run. The decline of the multiplier is larger when facing debt-elastic country risk premia. Also, government spending is more expansionary with more home bias in government purchases, more sectoral rigidities, and a less flexible exchange rate. Whether the twin-deficit hypothesis holds depends crucially on the extent to which government deficits are financed externally.

Suggested Citation

  • Wenyi Shen & Susan S. Yang, 2012. "The Effects of Government Spending Under Limited Capital Mobility," IMF Working Papers 12/129, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:12/129

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    References listed on IDEAS

    1. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. VĂ©gh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters,in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
    2. Edward C. Skelton, 2008. "Reaching Mexico's unbanked," Economic Letter, Federal Reserve Bank of Dallas, vol. 3(jul).
    3. Uribe, Martin & Yue, Vivian Z., 2006. "Country spreads and emerging countries: Who drives whom?," Journal of International Economics, Elsevier, vol. 69(1), pages 6-36, June.
    4. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-185, March.
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    Cited by:

    1. Srecko Zimic & Romanos Priftis, 2017. "Sources of Borrowing and Fiscal Multipliers," 2017 Meeting Papers 294, Society for Economic Dynamics.


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