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Financial Friction and Household Debt: a new Perspective on the Twin Deficit Problem (Full text)
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We examine the international transmission of fiscal shocks in open economy, using a model combining heterogeneity of thrift with imperfect enforceability of contract as a motivation for the presence of financial frictions. This model generates twin deficits in response to a temporary cut in lump-sum taxes, overcoming a limitation of both standard RBC and New Keynesian models . Household debt and financial frictions amplify the effects of shocks to lump-sum taxes, but play a moderate role in the transmission of government expenditure shocks. The theoretical responses generated by this model are in line with those estimated using a VAR on U.S. data from 1973 to 2004. It is also shown that liberalization and structural changes in the asset markets --- relaxing the collateral constraint in the credit market --- magnifies the movement of the current account in response to fiscal shocks.
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Government Expenditure, Durable Goods and Rule-of-Thumb behaviour (Full text)
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The effects of government expenditure shocks are analyzed in an economy with durable goods, household debt and collateral constraints. These features permit a more careful analysis of private consumption, whose observed response to an exogenous increase in government expenditure cannot be easily reconciled with standard optimizing models.
A recent extension of the New-Keynesian model (Gali, Lopez-Salido and Vallés, 2005) can successfully explain the consumption response by introducing rule-of-thumb agents; by nesting this specification and, at the same time, provides a more microfounded justification for the consumption behavior of these agents we show that the main result obtained by Gali et al. (2005) is no more in place as soon as we introduce durable goods and allow for household debt and collateral constraints: the fall in the collateral's price constitutes an additional, negative wealth effect that reduces aggregate consumption. We also show that unbinding the borrowing constraint does not help in generating a positive consumption response.
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Buffer Stock Savings, Consumption and Government Spending Shocks
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We use a New-Keynesian model with Calvo pricing, Walrasian labour markets and heterogeneous agents to analyze the effects of government spending on consumption. Along with the usual fully optimizing Ricardian agents we introduce a second group which mimics the behavior of agents with precautionary savings motive as in Carroll(1997).
By assuming a negative relation between expected consumption growth and cash-on-hand the model generates a positive consumption response after a government expenditure shock with a positive, but low, real wage response: this is consistent with VAR evidences on fiscal policy in the US.
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Demand Components and Import Determination
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Work in progress...
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Private Debt, Fiscal Shocks and Relative Price Determination
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Work in progress...
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