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Short-run analysis of fiscal policy and the current account in a finite horizon model

Abstract

This paper utilizes a technique developed by Judd to quantify the short-run effects of fiscal policies and income shocks on the current account in a small open economy. It is found that: (1) a future increase in government spending improves the short-run current account; (2) a future tax increase worsens the short-run current account; (3) a present increase in the government spending worsens the short-run current account dollar by dollar, while a present increase in the income improves the current account dollar by dollar; (4) when government budget is balanced in the long run, a tax cut accompanied by an equal government spending cut in the future always leads to a deterioration in the short-run current account.

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