Trade Flows and Fiscal Multipliers

Abstract

We present novel insights on the role of international trade following unanticipated government spending and income tax changes in a flexible exchange rate environment. In a simple two-country, two-good model, we show analytically that fiscal multipliers can be larger in economies more open to trade, even when fiscal expansions imply a trade deficit. Cross-country comovement can be positive or negative. Three factors determine how trade linkages affect fiscal multipliers: the relative import share of public and private goods, how the government finances its budget, and the currency invoicing of exports. A Bayesian prior-predictive analysis shows a quantitative international business-cycle model bears the same predictions. Estimating the model on Canadian and U.S. data, we find support for larger multipliers relative to a counterfactually closed economy and positive cross-country spillovers. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.