Working Paper: NBER ID: w1429
Authors: Willem H. Buiter
Abstract: The paper studies the effects of alternative financing policies in the open economy.There is a non-trivial role for financial policy because of the failure of first-order debt neutrality due to uncertain private lifetimes. Both the single-country case and the interdependent two-country case are considered. Capital formation is endogenous and there are unified global financial and goods markets determining the interest rate, each country's"Tobin's q" and the terms of trade. The government's present value budget constraint or solvency constraint and the assumption that the interestrate exceeds the growth rate imply that, given spending, current tax cutsimply future tax increases. Such policies boost the outstanding stock of public debt, raise the world interest rate, crowd out capital formation at home and abroad, and lead to a loss of foreign assets. Provided a"supply-side-response-corrected" transfer criterion is satisfied, the terms of trade will improve in the short run and worsen in the long run.
Keywords: Fiscal Policy; Open Economies; Capital Formation; Public Debt; Interest Rates
JEL Codes: E62; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| current tax cuts (H29) | future tax increases (H29) |
| increased public debt (H69) | world interest rate (E43) |
| world interest rate (E43) | domestic capital formation (E22) |
| current tax cuts (H29) | increased public debt (H69) |
| increased public debt (H69) | terms of trade (F14) |