Excess Savings and Twin Deficits: The Transmission of Fiscal Stimulus in Open Economies

This paper studies the effects of debt-financed fiscal transfers in a general-equilibrium, heterogeneous-agent model of the world economy, merging a closed-economy HANK fiscal model (Auclert, Rognlie and Straub 2018) with an open-economy HANK model (Auclert, Rognlie, Souchier and Straub 2021) and, going beyond a small-open-economy assumption, letting fiscal deficits move the world interest rate as in Frenkel and Razin (1986). Its central analytical result is that fiscal deficits are eventually financed entirely by foreigners – in the long run, a country’s public debt increase leaves its private wealth unchanged and is absorbed one-for-one abroad (Proposition 1) – but that this happens only gradually. In the short run, because households have high, realistic marginal propensities to consume (MPCs) and spend mostly on home-biased domestic goods, almost all of a fiscal deficit shows up as a rise in the deficit country’s own private saving (“excess savings”), while the current account deteriorates only slowly (a “slow-motion twin deficit”), with a transition speed set jointly by the matrix of intertemporal MPCs and the degree of home bias. The paper shows analytically that the world economy decomposes into an aggregate, closed-economy-like response to the world-average fiscal shock and a small-open-economy-like response of each country’s deviation from that average, and it tests this prediction against cross-country data on private savings, current accounts and fiscal deficits since the start of the Covid pandemic, finding that a simple cross-sectional regression coefficient closely matches the model’s calibrated prediction after five quarters. A quantitative extension with 26 asymmetric countries and an explicitly estimated Covid demand shock replicates these patterns and finds that fiscal deficits, not the pandemic shock itself, account for the large majority of observed excess savings.

Rishabh Aggarwal | Macro Paper Warehouse

Excess Savings and Twin Deficits: The Transmission of Fiscal Stimulus in Open Economies