The Effects of Government Spending Under Limited Capital Mobility

Wenyi Shen and Susan Yang

No 2012/129, IMF Working Papers from International Monetary Fund

Abstract: This paper studies the effects of government spending under limited international capital mobility, as featured by most developing countries. While external financing of government debt mitigates the crowding-out effect, it generates real appreciation, which contracts traded output and lowers the fiscal multiplier in the short run. The decline of the multiplier is larger when facing debt-elastic country risk premia. Also, government spending is more expansionary with more home bias in government purchases, more sectoral rigidities, and a less flexible exchange rate. Whether the twin-deficit hypothesis holds depends crucially on the extent to which government deficits are financed externally.

Keywords: WP; government spending; fiscal policy; fiscal multipliers; small-open DSGE models; developing countries; imperfect capital mobility; government spending effect; real interest rate; external financing; government spending policy; central bank; nominal exchange rate; exchange rate regime; Consumption; Capital account; Real exchange rates; Caribbean; Global (search for similar items in EconPapers)
Pages: 41
Date: 2012-05-01
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Citations: View citations in EconPapers (4)

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