The International Transmission of Fiscal Expenditures and Budget Deficits in the World Economy

Abstract

This paper deals with the international transmission of the effects of fiscal expenditures and budget deficits. One of the major sources of recent friction between Europeans and Americans has been the interpretation of the economic implications of US budget deficits. Theorists and policymakers on both sides of the Atlantic have differed in the analysis of the role of budget deficits in affecting key macroeconomic aggregates. Specifically, some have argued that large budget deficits are responsible for the recently observed high real rates of interest while others have claimed that budget deficits cannot be blamed for these real rates. The latter group claimed that theory does not predict a clear-cut relation between budget deficits and rates of interest and that the empirical record itself is very weak.

Parts of this paper were written during the Fall of 1983 while J. A. Frenkel was a Fellow at the Sackler Institute for Advanced Studies at Tel-Aviv University, Israel, and during the winter of 1984 while A. Razin was a visiting Professor at the Woodrow Wilson School of International Affairs, Princeton University. The final draft was prepared during the summer of 1984 while both authors participated in the Summer Institute of the NBER. We are indebted to these institutions as well as to Itzhak Gilboa for assistance in the computations. In revising the paper we have benefited from useful comments by J. Aizenman, G. Calvo, A. Dixit, R. Dornbusch, E. Helpman, R. E. Lucas, Jr., F. Modigliani, M. Mussa, M. Obstfeld, T. J. Sargent and L. Svensson. The research reported here is part of the NBER’s research programme in International Studies and Economic Fluctuations. Any opinions are those of the authors and not of the National Bureau of Economic Research.