Habit Formation and Fiscal Transmission in Open Economies

31 Pages Posted: 22 Nov 2010

See all articles by Olivier Cardi

Olivier Cardi

Université Paris II - Panthéon-Assas - ERMES

Gernot J. Müller

University of Tuebingen - Department of Economics

Date Written: October 2010

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. In a first step, we identify government spending shocks within a vector autoregression model. We find that i) government spending increases output and induces a simultaneous decline of investment and the current account, but does not affect consumption; ii) the responses of output and investment are smaller in more open economies, while current account deficits tend to be larger. We find the predictions of the model to be broadly in line with the evidence, once we allow for habit formation in consumption. Specifically, habits are crucial for government spending to induce a simultaneous decline in investment and the current account.

Keywords: Current Account, Fiscal Policy, Habit formation, Investment

JEL Classification: E32, E62, F41

Suggested Citation

Cardi, Olivier and Müller, Gernot J., Habit Formation and Fiscal Transmission in Open Economies (October 2010). CEPR Discussion Paper No. DP8035, Available at SSRN: https://ssrn.com/abstract=1711048

Olivier Cardi (Contact Author)

Université Paris II - Panthéon-Assas - ERMES ( email )

12 Place du Panthéon
Paris, Cedex 5, 75005
France

Gernot J. Müller

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

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