International Effects of Government Expenditure in Interdependent Economies

Abstract

A dynamic analysis of the international transmission of government expenditure shocks under alternative methods of finance is presented. The benchmark case of lump-sum tax financing yields an expansion in both the short-run and the long-run levels of domestic activity, while crowding out domestic consumption. Activity abroad declines in the short run, and while it is stimulated during the transition, long-run activity abroad also declines. With capital income tax financing, the accompanying distortion outweighs the direct expenditure effects, so that all these responses are reversed. Financing with a tax on labour produces ambiguous responses. The welfare implications of these policies are also examined. Effets internationaux de la depense gouvernementale dans des economies interdependantes. Les auteurs presentent une analyse dynamique de la transmission internationale de chocs dans la depense gouvernementale selon la methode de financement utilisee. Le cas qui sert de point de reference est le financement via un impot forfaitaire qui entraine une expansion dans le niveau d'activite economique au niveau domestique tant 'a long terme qu'a court terme, tout en ayant un effet d' eviction sur le niveau de consommation domestique. Le niveau d'activite economique outre-frontieres chute 'a court terme et meme si le niveau d'activite 'a long terme chute aussi, il y a stimulation de l'activite economique dans la periode de transition. Quand le financement est fait par le truchement d'un imp6t sur le revenu du capital l'effet de distorsion domine les effets de depenses directes, ce qui fait que ces reactions sont renversees. Les effets d'un financement par le truchement d'un imp6t sur le revenu du travail sont ambigus. Les auteurs examinent aussi les effets sur le niveau de bien-&re de ces diverses politiques. I. INTRODUCTION The international transmission of fiscal disturbances has long been a central issue in intemational macroeconomics. Early analyses examined this issue using variants An earlier draft of this paper benefited from comments at the International Economics Lunch Group of the NBER, as well as from participants at the Summer 1994 Research Workshop at the University of Warwick. We appreciate the constructive comments of two anonymous referees.

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