Habit formation and fiscal transmission in open economies |
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| Institution: | 1. World Trade Organization, Rue de Lausanne 154, 1202 Geneva, Switzerland;2. School of Economics and Management, Leibniz University of Hanover, Königsworther Pl. 1, Hanover 30167, Germany;3. International Monetary Fund, 700 19th St NW, Washington, DC 20431, United States;1. Banque de France, Monetary Policy Division, 31 rue Croix des Petits-Champs, 75049 Paris Cedex 1, France;2. Department of Economics, University of Cyprus, 1678 Nicosia, Cyprus;1. University of Passau, Dr.-Hans-Kapfinger-Straße 14b, 94032 Passau, Germany;2. PSE-Ecole des Ponts Paris Tech, 48 Boulevard Jourdan, 75014 Paris, France;3. CEPR, United Kingdom |
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| Abstract: | In this paper we analyze the ability of an open economy version of the neoclassical model to account for the time-series evidence on fiscal policy transmission. Revisiting the evidence, we find that i) government spending raises output, while inducing a simultaneous decline of investment and the current account and ii) the responses of output and investment are more muted in more open economies while current account deficits tend to be larger. Turning to the model, we explore the role of habit formation for fiscal policy transmission. Specifically, we show that the model can account for the evidence if consumption behavior is characterized by habit formation and the terms of trade adjust endogenously. |
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