An examination of the effects of government purchases in an open economy

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This paper examines the effects of permanent and transitory changes in government purchases in the context of a model of a small open economy that produces and consumes both traded and nontraded goods. The model incorporates an equilibrium interpretation of the business cycle that emphasizes the responsiveness of agents to intertemporal relative price changes. It is demonstrated that transitory increases in government purchases lead to an appreciation of the real exchange rate and an ambiguous change (although a likely worsening) in the current account, while permanent increases have an ambiguous impact on the real exchange rate and no effect on the current account. When agents do not know whether a given increase in government purchases is permanent or transitory the effect is a weighted average of these separate effects. The weights depend on the relative variances of the transitory and permanent components of government purchases. © 1985.






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Kimbrough, KP (1985). An examination of the effects of government purchases in an open economy. Journal of International Money and Finance, 4(1). pp. 113–133. 10.1016/0261-5606(85)90009-9 Retrieved from

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Kent P. Kimbrough

Professor of Economics

Professor Kimbrough specializes in the fields of macroeconomics and international economics. His latest research explores the revenue maximizing inflation rate, optimal taxes and tariffs in the presence of private information, the welfare costs of inflation, and interest rate rules and uniqueness in the presence of transactions costs. In prior work he has investigated the macroeconomic effects of trade policy, the impact of bilateral tariffs, foreign exchange controls and capital controls, the real effects of inflation, optimal taxation and Friedman’s rule, and the information content of prices and the role of monetary policy. His most recent published work investigates “Optimal Taxes and Tariffs with Private Information” and “Revenue Maximizing Inflation.” His earlier work explored such subjects as “Price, Output, and Exchange Rate Movements in the Open Economy,” “Aggregate Information and the Role of Monetary Policy in an Open Economy,” “Foreign Aid and Optimal Fiscal Policy,” “An Investigation in the Theory of Foreign Exchange Controls,” “The Optimum Quantity of Money Rule in the Theory of Public Finance,” and “Tax Regimes, Tariff Revenues, and Government Spending.”

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