DP21 On Fiscal Deficits, the Real Exchange Rate and the World Rate of Interest

Author(s): Sweder van Wijnbergen
Publication Date: July 1984
Keyword(s): Budget Deficit, Fiscal Policy
JEL(s): 322, 411
Programme Areas: International Macroeconomics, International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=21

We use a full general equilibrium 2-country, 2-period model with perfect capital markets, and intertemporal optimization and perfect foresight underlying private consumer behaviour in both countries to analyse the effects of pure fiscal policy. We demonstrate that higher government budget deficits in one country caused by a cut in commodity taxes today balanced by an equal present value increase tomorrow, will not be offset one for one by higher private savings, because of pure substitution effects triggered by the change in the intertemporal terms of trade the tax change causes.