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Government deficits, private investments and the current account : an intertemporal disequilibrium analysis (English)

This paper uses a model with full intertemporal optimization and Fischer-Gray type short run real wage rigidities to demonstrate the effects of deficit spending in different employment regimes. It allows for upward price flexibility, although prices, once set at the beginning of the period, will be rigid downward until the beginning of the next period. The paper shows that under Keynesian unemployment, deficit spending reduces unemployment, improves the future terms of trade and therefore leads to an increase in private investment and to a deterioration of the Current Account. Under classical unemployment, goods markets clear but unemployment persists because of contract based real wage rigidity. Finally, the paper shows that, the more open the economy is, the larger is the output response and the smaller the price response to a fiscal expansion in the presence of classical unemployment. This contrasts with the Keynesian unemployment regime, where a higher import component in expenditure leads to more dissipation of effective demand and smaller output effects.

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Citation

Van Wijnbergen,Sweder

Government deficits, private investments and the current account : an intertemporal disequilibrium analysis (English). Development Research Department discussion paper ; no. DRD 256 Washington, D.C. : World Bank Group. http://documents.worldbank.org/curated/en/878191468170676260/Government-deficits-private-investments-and-the-current-account-an-intertemporal-disequilibrium-analysis