Working Paper: CEPR ID: DP491
Authors: Frederick van der Ploeg
Abstract: A two-country, intertemporal, perfect-foresight model with micro foundations, floating exchange rates, uncovered interest parity, and nominal wage rigidities is formulated. The benchmark case corresponds to unit elasticities of intertemporal and intratemporal substitution in consumption, no initial holdings of foreign assets and infinite lifetimes. Monetary disinflation and an increase in government spending then have no spillover effects on foreign consumption and employment and there are no current account dynamics. Four channels of international policy transmission are then analysed. The first is based on capital gains on holdings of foreign assets. The spillover effects arising through the second and third channel depend on whether goods are gross substitutes or gross complements and on whether the elasticity of intertemporal substitution is less or greater than unity. The final channel assumes finite lifetimes and no bequest motive. It departs from debt neutrality in order to allow wealth effects and current account dynamics to play a more interesting role and to assess the difference between tax and debt finance.
Keywords: intratemporal substitution; intertemporal substitution; revaluation effects; finite lives; spillover effects; fiscal and monetary policies
JEL Codes: 430
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| domestic monetary policy (E52) | foreign consumption (F10) |
| domestic monetary policy (E52) | unemployment (J64) |
| exchange rate appreciation (F31) | real value of foreign assets (F31) |
| elasticity of intratemporal substitution (D11) | spillover effects of monetary disinflation (E31) |
| goods as gross substitutes (D10) | foreign consumption (F10) |
| goods as gross complements (D10) | foreign consumption (F10) |
| elasticity of intertemporal substitution > 1 (D15) | accumulation of foreign assets (F21) |
| elasticity of intertemporal substitution < 1 (D15) | decrease in foreign assets (F32) |
| finite lifetimes and absence of bequest motive (D15) | disrupt Ricardian debt neutrality (E62) |
| disruption of Ricardian debt neutrality (H69) | current account dynamics (F32) |
| disruption of Ricardian debt neutrality (H69) | significant spillover effects (D62) |