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Fiscal Deficits as a Source of Boom and Bust under a Common Currency

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  • Giovanni Ganelli
  • Neil Rankin

Abstract

We investigate in depth, using predominantly analytical, rather than numerical, methods, the mechanisms which operate following a one-period, debt-financed, fiscal deficit in a small open economy operating under a common currency. The economy incorporates the New Keynesian features of staggered price setting and overlapping generations. Unsurprisingly, these features cause the impact effect to be a boom, in the sense of a positive output gap. However we also find that the boom must later turn into a bust, or negative output gap. Moreover inflation also follows a boom-bust pattern and on average there is deflation rather than inflation.

Suggested Citation

  • Giovanni Ganelli & Neil Rankin, 2018. "Fiscal Deficits as a Source of Boom and Bust under a Common Currency," Discussion Papers 18/05, Department of Economics, University of York.
    • Handle: RePEc:yor:yorken:18/05
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    More about this item

    Keywords

    staggered prices; overlapping generations; small open economy; currency union; fiscal deficits; government debt; output gap;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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