Academic journal article Atlantic Economic Journal

The Mundell Proposition with Productive Public Spendings

Academic journal article Atlantic Economic Journal

The Mundell Proposition with Productive Public Spendings

Article excerpt

International macroeconomic literature has long agreed that fiscal policy is totally ineffective in changing the output under flexible exchange rates with perfect capital mobility. This result is dubbed the Mundell proposition [Can. J. of Eco. and Political Science, 1963]. This note demonstrates that the consensus will be reversed if the effects of government services on aggregate supply are introduced, from the viewpoint that government purchases are allowed to influence private productivity [Grossman and Lucas, Manchester Schoo, 1974; Barro, JPE, 1981].

The model in the context of flexible rates with perfect capital mobility is given by:

y = E(y,r*) + g + B(y,q);

1 > Ey > 0, By < 0, Bq > 0, (1)than]

M/p = L(y, [r.sup.*]); [L.sub.y] [is greater than] 0, (2)

y = S(p,g); [S.sub.p] > 0, [S.sub.g] [is greater than or equal to] 0, (3)

where: y = real output; E = expensiture on consumption and investment; [r.sup.*] = world interest rate; g = government spending; B = the trade balance; e = price of foreign currency in terms of domestic currency; [p.sup.*] = foreign currency price of imports; p = price of domestic goods; q = e[p.sup.*]/p = terms of trade; M = nominal money supply; L = real money demand; and S = supply of output. Equations (1) and (2) represent the economy's IS and LM curves, respectively. Equation (3) is the aggregate supply function. …

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