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This paper examines the effects of fiscal policies on the evolution of real rates of interest and real exchange rates in the interdependent world economy.We construct an analytical framework suitable for a detailed examination of the various channels through which these variables are influenced by government spending and by tax policies. The analytical framework employs a general equilibrium approach highlighting the roles played by wealth effects and by temporal and intertemporal substitution effects.The general principle illustrated by the analysis of the dynamic effects of budget deficits is that the consequences of temporary tax policies stretch beyond the period during which the temporary policies are in effect. The counterpart to these dynamic implications is the rise in the economy's external debt induced by the budget deficit the service of which stretches into the indefinite future. By series of examples, allowing for both distortionary and non-distortionary taxes and for various patterns of government spending, it is shown that the quantitative and qualitative effects of fiscal policies on real exchange rates, real interest rates, debt accumulation and the like depend critically on the commodity composition of government spending and its intertemporal allocations on the one hand, and on the details of government debt issue and tax structure, including the timing of taxes and borrowing and the types of taxes used to finance the budget, on the other hand.
Jacob A. Frenkel Assaf Razin Department of Economics Department of Economics University of ChicagoTel-Aviv University 1126 E. 59th Street Ramat-Aviv, Tel-Aviv Chicago, IL 60637 Israel (312) 962-8253 (972)-3-420-733 This paper deals with the effects of fiscal policies on the evolution of real rates of interest and real exchange rates in the interdependent world economy.The main purpose of the analysis is to construct an analytical framework suitable for a detailed examination of the various channels through which government spending and tax policies influence interest rates and real exchange rates. Such an analysis clarifies the mechanisms through which the effects of fiscal policies are transmitted internationally.Our analysis is motivated by developments occuring in the world economy during the first half of the 1980's. During this period changes in national fiscal policies were unsynchronized, real rates of interest were high and volatile and real exchange rates exhibited diverging trends and were subject to large fluctuations. The course of fiscal policies undertaken by the major industrial countries affected the rest of the world through the integrated goods and capital markets and resulted in increased concern in each country over policy measures taken in the rest of the world. In addition to the interactions among the major economies, the debt-ridden countries faced with high world interest rates adopted fiscal policy measures that influenced their competitive position and external-debt accumulation. Our analysis provides a framework u...
The paper develops a model of foreign direct investments (FDI) and foreign portfolio investments (FPI). FDI enables the owner to obtain refined information about the firm. This superiority, relative to FPI, comes with a cost: a firm owned by the FDI investor has a low resale price because of asymmetric information between the owner and potential buyers. The model can explain several stylized facts regarding foreign equity flows, such as the larger ratio of FDI to FPI inflows in developing countries relative to developed countries, and the greater volatility of FDI net inflows relative to FPI net inflows.
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