International dimensions of fiscal policy transmission

Abstract

The global integration of goods and asset markets alters alters how fiscal shocks impact the economy and are propagated across countries. Using standard business cycle analysis we explore this international dimension of fiscal policy transmission. Most importantly, we find that the smaller and the more open an economy, the more likely will private investment rise following a fiscal expansion. This is because it appreciates the terms of trade and lowers the price of capital goods in terms of their return. An immediate implication is that smaller and more open economies are more likely to experience twin deficits.