Fiscal Deficits, Current Account Dynamics and Monetary Policy

Di Giorgio, Giorgio and Nisticò, Salvatore (2008) Fiscal Deficits, Current Account Dynamics and Monetary Policy. [Working Paper]. p. 43. Working Papers (No. 8).

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This paper develops a stochastic two-country "perpetual youth" Dynamic New Keynesian model of the international business cycle with incomplete international financial markets and stationary net foreign assets. The model allows for a thorough analysis of the interaction of endogenous monetary policy with endogenous, non-balanced budget fiscal policy. We derive the dynamic and cyclical properties of fiscal deficit feedback rules under alternative monetary regimes, discuss the international transmission of productivity shocks, and the implications for net foreign assets and exchange rate dynamics. Our results imply that the degree of "fiscal discipline", i.e. the extent to which the fiscal rule responds to debt dynamics, is crucial for the dynamics of net foreign assets. We show that under low fiscal discipline (characterizing most industrialized countries, first and foremost the U.S.) temporary positive productivity shocks may result in highly persistent deteriorations of the external position in the medium run. Our results also suggest that any attempt by monetary policy alone to stabilize the dynamics of net foreign assets would induce excessive and costly fluctuations of the exchange rate.

Item Type: Report / Paper (Working Paper)
Research documents and activity classification: Working Papers > Non-Refereed Working Papers / of national relevance only
Divisions: Department of Business and Management
Uncontrolled Keywords: Fiscal Deficit, Current Account, DSGE Models, Monetary and Fiscal Policy
MIUR Scientific Area: Area 13 - Economics and Statistics > SECS-P/01 Political Economy
Deposited by: Maria Teresa Nistico
Date Deposited: 23 Nov 2010 08:18
Last Modified: 22 Apr 2015 00:13

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