The Effects of Government Spending Under Limited Capital Mobility
IMF Working Papers, May 1, 2012
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Bibliographic details
- Authors: Wenyi Shen, Susan S. Yang
- Published: May 1, 2012
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475503661.001
Key findings
- External financing of government debt mitigates the crowding-out effect.
- External financing generates real appreciation, which contracts traded output and lowers the fiscal multiplier in the short run.
- The decline of the fiscal multiplier is larger when facing debt-elastic country risk premia.
- 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.
Mechanisms and channels analyzed
- Interaction between limited international capital mobility and fiscal policy.
- Trade-off between external debt financing reducing domestic crowding-out versus causing real exchange rate appreciation.
- Role of debt-elastic country risk premia in amplifying multiplier decline.
- Influence of home bias in government purchases and sectoral rigidities on the responsiveness of aggregate demand to government spending.
- Exchange rate flexibility as a determinant of the expansionary effect of government spending.
Policy implications
- Financing composition of government deficits matters for short-run fiscal effectiveness: greater external financing can reduce domestic crowding-out but may lower the fiscal multiplier through real appreciation.
- Countries with debt-elastic country risk premia should expect a larger reduction in the fiscal multiplier when relying on external financing.
- Policies that account for sectoral rigidities and home bias in government consumption can strengthen the expansionary impact of government spending.
- Exchange rate policy influences fiscal effectiveness: less flexible exchange rates make government spending more expansionary.
Subjects and keywords (as presented)
- Subjects: Balance of payments, Capital account, Consumption, Expenditure, Fiscal multipliers, Fiscal policy, Foreign exchange, National accounts, Public debt, Real exchange rates
- Keywords: Capital account, Caribbean, central bank, Consumption, developing countries, exchange rate regime, external financing, fiscal multipliers, fiscal policy, Global, government spending, government spending effect, government spending policy, imperfect capital mobility, nominal exchange rate, Real exchange rates, real interest rate, small-open DSGE models, WP
Wenyi Shen and Susan S. Yang, "The Effects of Government Spending Under Limited Capital Mobility", IMF Working Paper (May 1, 2012).