Abstract
This paper extends Diamond's overlapping generations model into a two‐good, two‐country setting to analyze the impact of an increase in domestic government debt on the terms of trade, the current account, and capital accumulation at home and abroad. It is found that, while the direction of change in the terms of trade is indeterminate in the short run, for stability it must agree with that in the steady state, which in turn is dependent on the initial debt status in trade of the home country. The higher level of government debt leads unambigously to lower levels of capital stocks, however.
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