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International Transmission of Fiscal Shocks: An Empirical Investigation

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Abstract

This paper investigates how innovations in income taxes and government purchases originating in the U.S. affect the U.S. economy, and how these effects are transmitted to the Canadian economy. Using a semi-structural VAR model and data for both countries for the 1961:1-2004:3 period, we find that fiscal policy innovations originating in the U.S. are transmitted to the Canadian economy by international trade and capital flows through interest rate and exchange rate channels. Unanticipated shocks to U.S. government purchases have beggar thy neighbor effects on Canada. U.S. output increases and Canadian output decreases in response to a positive shock to U.S. government purchases. In response to an unanticipated increase in U.S. income taxes, U.S. output declines while U.S. and Canadian real interest rates rise. The response of Canadian output, however, is not significantly different from zero.

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  • Faik Koray & K. Peren Arin, 2006. "International Transmission of Fiscal Shocks: An Empirical Investigation," Departmental Working Papers 2006-03, Department of Economics, Louisiana State University.
    • Handle: RePEc:lsu:lsuwpp:2006-03
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