The Zero-Root Property : Permanent vs Temporary Terms of Trade Shocks

This contribution shows that the persistence and the time of occurence of the shock matter in determining the long-run macroeconomic aggregates’ responses after permanent and transitory terms of trade shocks. Within a simple two-good small open economy model, we differentiate analyticaly between the (long-run) effects of four types of negative terms of trade disturbances of different degrees of persistence and occurence. We distinguish between permanent and transitory shocks, on the one hand, and between anticipated and unanticipated shocks, on the other hand, and finally we consider a permanent perturbation but viewed as temporary by agents. The application of a new analytical two-step procedure to the zero-root property case allows to obtain new conclusions not developed by previous studies : (i) a strong persistent terms of trade worsening may induce a decline in the long-run in the real expense and in the stock of net foreign assets greater than after a permanent disturbance, (ii) real expense may rise or fall in the long-run after an anticipated future permanent negative external shock depending on the time of occurence of the disturbance, and (iii) fails in expectation may induce large cut in real expense and translate into large losses in welfareSmall open economy; Terms of trade; Savings; Temporary shock

Another View of the J-Curve

We use a two-good dynamic optimizing small open economy model to provide a new explanation of the J-Curve phenomenon in terms of habit persistence in consumption and sluggishness in capital adjustment. The results differ markedly depending on the permanence or temporary nature of the relative price change. A short-lived terms of trade worsening may lead to a once-for-all decrease in the marginal utility of wealth and to higher steady-state values of the habitual standard of living, the real expense, and the net foreign assets through the combination of intertemporal speculation, inertia, and hysteresis effects. Investment and real expense folow non-monotonic transitional paths and current account dynamics are driven by new forces. In accordance with recent empirical results, investment is procyclical, trade balance deteriorates initially, net foreign assets adjustment exhibits a J-Curve, and the current account surplus phase is associated with a fall in real income.Current account; Habit Formation; Temporary Shock; J-Curve

A note on the crowding-out of investment by public spending

One of the most prominent and consistent findings of the recent empirical literature on fiscal policy is that investment expenditure is crowded-out by public spending in the short-run. In this contribution, we address this empirical fact using a dynamic general equilibrium model and show that the introduction of a habit-forming behavior plays a major role in accommodating the observed negative relationship between investment and government expenditure. Our numerical experiments point out the role of consumption inertia in determining the reactions of the open economy: as habit persistence gets stronger, a fiscal expansion crowds-out real consumption by a smaller amount and investment by a larger one, while the current account enters into a greater deficit.Investment; Habit Formation; Current Account; Fiscal Expansion

Unanticipated vs. Anticipated Tax Reforms in a Two-Sector Open Economy.

We use a two-sector neoclassical open economy model with traded and non-traded goods to investigate the effects of unanticipated and anticipated tax reforms. First, an unanticipated tax reform produces an expansion of GDP, labor, and investment, while an anticipated tax reform has opposite effects before the implementation of the labor tax cut. Quantitatively, if the traded sector is more capital intensive, GDP increases by 1.6 percentage points or declines by 2.8 percentage points after three years, depending on whether the tax cut is unanticipated or anticipated. Second, we find that GDP change masks a wide dispersion in sectoral output responses. Importantly, in all scenarios, a tax reform substantially raises the relative size of the non-traded sector while traded output always drops. Allowing for the markup to depend on the number of competitors, we find that a significant share of GDP change can be attributed to the competition channel while the dispersion of sectoral output responses is amplified. Finally, the workers only benefit from the labor tax cut if the tax change is unanticipated and the traded sector is more capital intensive.Non Traded Goods; Investment; Tax Reform; Anticipation effects.

Tax Reform in Two-Sector General Equilibrium

We use a two-sector open economy model with an imperfectly competitive non traded sector to investigate the dynamic and steady-state effects of three tax reforms : [i] two revenue-neutral tax reforms shifting the tax burden from labor to consumption taxes and [ii] one labor tax reform keeping the marginal tax wedge constant. Regardless of its form, a tax restructuring crowds-in consumption and investment and raises employment. While tax multipliers for overall output are always positive, their size depends on the type of the tax reform and the financing scheme. Interestingly, the trade balance plays a key role in determining the relative size of sectoral tax multipliers : whereas the long-term tax multiplier is always slightly higher in the traded sector than in the non traded sector, this result is reversed in the short-term. Finally, time horizon matters in determining the relationships between both overall and sectoral tax multipliers and labor responsiveness.non traded goods ; investment ; employment ; tax multiplier

Fiscal shocks in a two sector open economy

We use a two-sector neoclassical open economy model with traded and non-traded goods to investigate both the aggregate and the sectoral effects of temporary fiscal shocks. One central finding is that both sectoral capital intensities and labor supply elasticity matter in determining the response of key economic variables. In particular, the model can produce a drop in investment and in the current account, in line with empirical evidence, only if the traded sector is more capital intensive than the non-traded sector, and labor is supplied elastically. Irrespective of sectoral capital intensities, a fiscal shock raises the relative size of the non-traded sector substantially in the short-run. Additionally, allowing for the markup to depend on the number of competitors, the two-sector model can produce the real exchange rate depreciation found in the data. Finally, markup variations triggered by firm entry modify substantially the response of the real wage and the sectoral composition of GDP in the short-run.Non-traded Goods; Fiscal Shocks; Investment; Current Account.

Sectoral Effects of Tax Reforms in an Open Economy

We use a neoclassical open economy model with traded and non traded goods to investigate the sectoral effects of three tax reforms: i) two revenue-neutral shifting the tax burden from labor to consumption taxes and ii) one labor tax restructuring keeping the marginal tax wedge constant. Regardless of its type, a tax reform crowds-in both consumption and investment and raises employment. Whereas tax reforms have a small impact on GDP, they exert substantial effects on sectoral outputs which move in opposite direction in the short-run. The sensitivity analysis reveals that raising the elasticity of labor supply or reducing the tradable content in consumption expenditure amplifies the heterogeneity in sectoral output responses. Finally, allowing for the markup to depend on the number of competitors, we find that a substantial share of sectoral output variations can be attributed to the change in the markup triggered by firm entry.Non Traded Goods; Employment; Current Account; Tax Reform

Sectoral Effects of Tax Reforms in an Open Economy

We use a neoclassical open economy model with traded and non traded goods to investigate the sectoral effects of three tax reforms: i) two revenue-neutral shifting the tax burden from labor to consumption taxes and ii) one labor tax restructuring keeping the marginal tax wedge constant. Regardless of its type, a tax reform crowds-in both consumption and investment and raises employment. Whereas tax reforms have a small impact on GDP, they exert substantial effects on sectoral outputs which move in opposite direction in the short-run. The sensitivity analysis reveals that raising the elasticity of labor supply or reducing the tradable content in consumption expenditure amplifies the heterogeneity in sectoral output responses. Finally, allowing for the markup to depend on the number of competitors, we find that a substantial share of sectoral output variations can be attributed to the change in the markup triggered by firm entry.Non Traded Goods; Employment; Current Account; Tax Reform.

Fiscal Shocks in a Two-Sector Open Economy

We use a two-sector neoclassical open economy model with traded and non-traded goods to investigate both the aggregate and the sectoral effects of temporary fiscal shocks. One central finding is that both sectoral capital intensities and labor supply elasticity matter in determining the response of key economic variables. In particular, the model can produce a drop in investment and in the current account, in line with empirical evidence, only if the traded sector is more capital intensive than the non-traded sector, and labor is supplied elastically. Irrespective of sectoral capital intensities, a fiscal shock raises the relative size of the non-traded sector substantially in the short-run. Additionally, allowing for the markup to depend on the number of competitors, the two-sector model can produce the real exchange rate depreciation found in the data. Finally, markup variations triggered by firm entry modify substantially the response of the real wage and the sectoral composition of GDP in the short-run.Non-traded Goods; Fiscal Shocks; Investment; Current Account

Permanent vs Temporary Fiscal Expansion in a Two-Sector Small Open Economy Model

This contribution shows that the duration of a fisscal shock together with sectoral capital intensity matter in determining the dynamic and steady-state effects in an intertemporal-optimizing two-sector small open economy model. First, unlike a permanent shock, net foreign asset position always worsens in the long-run after a transitory fiscal expansion. Second, steady-state changes in physical capital depend on sectoral capital-labor ratios but their signs may be reversed compared to the corresponding permanent public policy. Third, investment and the current account may now adjust non monotonically. Fourth, a temporary fiscal shock always crowds-out (crowds-in) investment in the long-run whenever the non traded (traded) sector is more capital intensive.current account; government spending; nontraded goods; temporary shocks