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The International Transmission of Fiscal Expenditures and Budget Deficits in the World Economy

  • Jacob A. Frenkel
  • Assaf Razin

This paper analyses the effects of fiscal policies on rates of interest and wealth in the world economy. Uncertainty concerning the length of life yields an equilibrium in which private and social rates of discount differ and budget deficits exert real effects. It is shown that a current budget deficit(resulting from a tax cut) raises world rates of interest. On the other hand the direction of the effect of an expected future deficit on the short-term rate of interest depends on whether the country is having a surplus or a deficit inits current account of the balance of payments. If it runs a deficit in the current account then the short-term rate of interest rises and vice versa; the future rate of interest, however, must rise. It is also shown that budget deficits raise domestic wealth and lower foreign wealth and thus result in a negative transmission. In the long run, a higher steady-state value of government debt raises the steady-state world rate of interest but its effect on the long-run value of foreign wealth is ambiguous. The effects of changes in government spending depend on both the timing and the patterns of spending. A transitory (balanced-budget) rise in current government spending raises the current rate of interest and lowers domestic and foreign wealth while a transitory future rise in government spending lowers the current rate of interest, lowers domestic wealth and raises foreign wealth. A permanent rise in government spending lowers the rate of interest if the current account of the balance of payments is in deficit, and vice versa. Finally, the model is generalized to a multi-commodity world and the impact of policies are shown to depend on comparison among various spending and saving propensities of private sectors and of governments.

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File URL: http://www.nber.org/papers/w1527.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1527.

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Date of creation: Dec 1984
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Publication status: published as Frenkel, Jacob A. and Assaf Razin. "The International Transmission And Effects Of Fiscal Policies," American Economic Review, 1986, v76(2), 330-335.
Handle: RePEc:nbr:nberwo:1527
Note: ITI IFM
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  1. Buiter, Willem H., 1984. "Fiscal Policy in Open, Interdependent Economies," CEPR Discussion Papers 28, C.E.P.R. Discussion Papers.
  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. Ray C. Fair, 1977. "On Modeling the Economic Linkages among Countries," Cowles Foundation Discussion Papers 465, Cowles Foundation for Research in Economics, Yale University.
  4. Razin, Assaf & Svensson, Lars E. O., 1983. "The current account and the optimal government debt," Journal of International Money and Finance, Elsevier, vol. 2(2), pages 215-224, August.
  5. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  6. Jacob A. Frenkel & Carlos A. Rodriguez, 1982. "Exchange Rate Dynamics and the Overshooting Hypothesis," NBER Working Papers 0832, National Bureau of Economic Research, Inc.
  7. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467.
  8. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  9. Finn Kydland & Edward C. Prescott, 1980. "A Competitive Theory of Fluctuations and the Feasibility and Desirability of Stabilization Policy," NBER Chapters, in: Rational Expectations and Economic Policy, pages 169-198 National Bureau of Economic Research, Inc.
  10. Willem H. Buiter & Richard C. Marston, 1985. "International Economic Policy Coordination," NBER Books, National Bureau of Economic Research, Inc, number buit85-1, 07.
  11. Jacob A. Frenkel & Assaf Razin, 1984. "Budget Deficits and Rates of Interest in the World Economy," NBER Working Papers 1354, National Bureau of Economic Research, Inc.
  12. Joseph E. Stiglitz, 1983. "On the Relevance or Irrelevance of Public Financial Policy: Indexation,Price Rigidities and Optimal Monetary Policy," NBER Working Papers 1106, National Bureau of Economic Research, Inc.
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