A Fiscal Theory of Global Fluctuations
110 Pages Posted: 6 Sep 2022 Last revised: 6 Dec 2022
Date Written: August 30, 2022
The United States (US) seems safe relative to the rest of the world (ROW). Her macro quantities, asset prices and wealth share all rise relative to the ROW during global downturns. In order to explain countercyclical dynamics in i) the dollar and ii) global equity risk premia, modern international macro-finance models based on US exorbitant privilege require the exact opposite dynamics for US relative macro quantities and the US wealth share. To resolve this US safety puzzle, I emphasise a novel source of US specialness: her excess fiscal capacity vis-a-vis the ROW. Using a multi-country general equilibrium model with i) Epstein-Zin preferences, ii) endogenous innovation, iii) international technology adoption, I show that both my novel US safety facts and countercyclical dollar and global equity risk-premium dynamics are equilibrium responses to more expansionary US fiscal policy vis-a-vis the ROW during global downturns. This novel fiscal theory also hints at a negative policy externality: full exploitation of her excess fiscal capacity allows the US to extract a premium from the ROW during global downturns, a non-trivial tradeoff that US fiscal authorities should internalise moving forward.
Keywords: International Finance, Asset Pricing, Recursive Preferences, US Fiscal Policy, Global Wealth Distribution, Reserve Currency Paradox, Global Financial System
JEL Classification: E0, F3, F4, G1
Suggested Citation: Suggested Citation