This paper uses a two-country general equilibrium model of the world economy in order to analyze the effects of budget deficits and government spending on world rates of interest, consumption, and international indebtedness. It demonstrates the difference between the effects of fiscal expenditures and tax cuts as well as between the effects of current policies and expected future policies. It is shown that the qualitative effects of fiscal policies depend on whether the country introducing the policies runs a surplus or a deficit in its current account. Following the positive analysis of the short-run and the steady-state effects, the paper concludes with a normative analysis of the welfare implications of budget deficits.

In recent years the world economy has been subject to large and unsyncronized changes in fiscal policies, high and volatile real rates of tnterest, large fluctuations in real exchange rates, and significant variations in private-sector spending. This paper reviews some of the key facts characterizing the effects of fiscal policies during the first half of the 1980s and provides a simple analytical framework suitable for the interpretation of these facts. The analytical framework builds on a two-country model of the world economy which is applied to the analysis of the transmission and effects of various changes in the time profile of taxes and of government spending. Generally, the predictions of the model concerning the relation among the intercountry patterns of consumption, long and short-term real rates of interest, real exchange rates and fiscal policies are consistent with the stylized facts.

This paper uses a two-country general equilibrium model of the world economy in order to analyze the effects of budget deficits and government spending on world rates of interest, consumption, and international indebtedness. It demonstrates the difference between the effects of fiscal expenditures and tax cuts as well as between the effects of current policies and expected future policies. It is shown that the qualitative effects of fiscal policies depend on whether the country introducing the policies runs a surplus or a deficit in its current account. Following the positive analysis of the short-run and the steady-state effects, the paper concludes with a normative analysis of the welfare implications of budget deficits.