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International Portfolio Rebalancing and Fiscal Policy Spillovers

Sami Alpanda, Uluc Aysun and Serdar Kabaca

No 2022-01, Working Papers from University of Central Florida, Department of Economics

Abstract: We theoretically and empirically evaluate the spillover effects of debt-financed fiscal policy interventions of the United States on other economies. We first consider a two-country dynamic stochastic general equilibrium model with international portfolio rebalancing effects arising from an imperfect substitutability between short- and long-term domestic and foreign bonds. The model shows that US fiscal expansions financed by long-term debt issuance would, on net, hinder economic activity in the rest of the world (ROW). This is despite the standard trade channel’s net positive effect on the ROW economy given the depreciation in the ROW currency. The fall in ROW output occurs mainly due to the increase in the ROW term premia and long-term rates through the portfolio rebalancing channel, as the relative demand for ROW long-term bonds decreases following the increase in the supply of US long-term bonds accompanying the fiscal expansion. Testing the predictions of our theoretical model by using panel regressions and vector autoregressions, we find empirical support for the negative relationship between ROW output and US fiscal spending. The data also confirm the positive relationship between ROW term spreads and US fiscal spending.

Keywords: International portfolio rebalancing; international spillover effects of fiscal policy; preferred habitat; DSGE. (search for similar items in EconPapers)
JEL-codes: E62 F41 F42 (search for similar items in EconPapers)
Pages: 76 Pages
Date: 2022-05
New Economics Papers: this item is included in nep-dge, nep-fdg, nep-mac and nep-opm
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