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Habit formation and fiscal transmission in open economies

Research output: Contribution to journalJournal articlepeer-review

<mark>Journal publication date</mark>11/2011
<mark>Journal</mark>Journal of International Economics
Issue number2
Number of pages10
Pages (from-to)256-267
Publication StatusPublished
Early online date11/08/11
<mark>Original language</mark>English


In this paper we analyze the ability of an open economy version of the neoclassical model to account for the time-series evidence on fiscal policy transmission. Revisiting the evidence, we find that i) government spending raises output, while inducing a simultaneous decline of investment and the current account and ii) the responses of output and investment are more muted in more open economies while current account deficits tend to be larger. Turning to the model, we explore the role of habit formation for fiscal policy transmission. Specifically, we show that the model can account for the evidence if consumption behavior is characterized by habit formation and the terms of trade adjust endogenously.