Twin Deficits versus Unpleasant Fiscal Arithmetic in a Small Open Economy

Masahiro KAWAI () and Louis John Maccini ()

Journal of Money, Credit and Banking, 1995, vol. 27, issue 3, pages 639-58

Abstract: This paper studies fiscal deficits, consumption-saving behavior, current account imbalances, and exchange rates in a small open economy populated by households with finite lives. Suppose the government undertakes a bond-financed tax cut today. The authors find that if tax finance is anticipated primarily to be used in the future to close the deficit then 'twin deficits' will be observed today, but if money finance is anticipated primarily to be used in the future then current fiscal deficits will induce a decline in current consumption, thus creating trade surpluses, a result they term 'unpleasant fiscal arithmetic.' Copyright 1995 by Ohio State University Press.

Date: 1995
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