FISCAL DEFICITS AND INTERGENERATIONAL WELFARE IN ALMOST SMALL OPEN ECONOMIES

The intergenerational welfare effects of government deficits are exami ned in a simple life-cycle economy which can borrow at given interest rates and import at given prices but has unexploited market power in e xports. Despite perfect capital market integration, a deficit-financed tax cut to the current young causes an immediate real exchange rate a ppreciation, raising the after-tax wage by more than the tax cut and l owering the rate of return on domestic assets. Subsequently, the real exchange rate depreciates to a lower steady-state value, and the after -tax wage decreases by more than the tax increase needed to service th e larger deficit.