Fiscal policy and external adjustment: New evidence |
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Institution: | 1. Medical Physics Program, Department of Physics and Applied Physics, University of Massachusetts at Lowell, 1 University Ave., Olney Science Center, Lowell, MA 01854, USA;2. Department of Radiation Oncology, Brigham and Women''s Hospital, Dana-Farber Cancer Institute, Harvard Medical School, 450 Brookline Ave., Jimmy Fund Building, Boston, MA 02215, USA;3. Department of Sciences, Wentworth Institute of Technology, 550 Huntington Ave., Boston, MA 02115, USA;1. Department of Statistical Sciences and School of Economics, Management and Statistics, University of Bologna, Via Belle Arti, Bologna 41, I-40126, Italy;2. CSEF, University of Salerno, Via Giovanni Paolo II 132, Fisciano 84084, SA, Italy;3. University of Göttingen, Platz der Göttinger Sieben 3, 37073 Göttingen, Germany |
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Abstract: | Relatively little empirical evidence exists about countries' external adjustment to changes in fiscal policy and, in particular, to changes in taxes. This paper addresses this question by measuring the effects of tax and government spending shocks on the current account and the real exchange rate in a sample of four industrialized countries. Our analysis is based on a structural vector autoregression in which the interaction of fiscal variables and macroeconomic aggregates is left unrestricted. Identification is instead achieved by exploiting the conditional heteroscedasticity of the structural disturbances. Three main findings emerge: (i) the data provide little support for the twin-deficit hypothesis, (ii) the estimated effects of unexpected tax cuts are generally inconsistent with the predictions of standard economic models, except for the US, and (iii) the puzzling real depreciation triggered by an expansionary public spending shock is substantially larger in magnitude than predicted by traditional identification approaches. |
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Keywords: | Current account Exchange rate Government spending Structural vector autoregression Taxes Twin deficits C32 E62 F41 H20 H50 H60 |
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