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The Effects of Government Spending under Limited Capital Mobility

The Effects of Government Spending under Limited Capital Mobility by Wenyi Shen
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This paper studies the effects of government spending under limited international capital mobility, as featured by most developing countries. While external financing of government debt mitigates the crowding-out effect, it generates real appreciation, which contracts traded output and lowers the fiscal multiplier in the short run. The decline of the multiplier is larger when facing debt-elastic country risk premia. Also, government spending is more expansionary with more home bias in government purchases, more sectoral rigidities, and a less flexible exchange rate. Whether the twin-deficit hypothesis holds depends crucially on the extent to which government deficits are financed externally.
International Monetary Fund; May 2012
41 pages; ISBN 9781475562163
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Title: The Effects of Government Spending under Limited Capital Mobility
Author: Wenyi Shen; Shu-Chun S. Yang