We present novel insights on the role of international trade following unanticipated fiscal changes in a flexible exchange rate environment. We show analytically that fiscal multipliers can be larger in economies more open to trade, even when fiscal expansions imply trade deficits. Three factors determine how trade linkages matter: the relative import share of public and private goods, the financing of government debt, and the currency invoicing of exports. A Bayesian prior-predictive analysis shows that a quantitative model bears the same predictions. Conditioning on Canadian and U.S. data, we find support for larger multipliers relative to a counterfactually closed economy.

© 2020 The President and Fellows of Harvard College and the Massachusetts Institute of Technology
2020
The President and Fellows of Harvard College and the Massachusetts Institute of Technology

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