INTERNATIONAL EFFECTS OF GOVERNMENT EXPENDITURE IN INTERDEPENDENT ECONOMIES

A dynamic analysis of the international transmission of government exp enditure shocks under alternative methods of finance is presented. The benchmark case of lump-sum tax financing yields an expansion in both the short-run and the long-run levels of domestic activity, while crow ding out domestic consumption. Activity abroad declines in the short r un, and while it is stimulated during the transition, long-run activit y abroad also declines. With capital income tax financing, the accompa nying distortion outweighs the direct expenditure effects, so that all these responses are reversed. Financing with a tax on labour produces ambiguous responses. The welfare implications of these policies are a lso examined.