Labor‐Market Search, Financial Market Integration, and the Fiscal Multiplier

Abstract

We used a two‐country optimizing “new‐open‐economy macroeconomics” model to analyze the implications of financial market integration for the fiscal multiplier. The fiscal multiplier measures the accumulated effect of fiscal policy on output. Our model features a labor‐market friction in the form of labor‐market search. The conventional wisdom derived from the basic textbook version of the classic Mundell–Fleming model has been that financial market integration diminishes the fiscal multiplier. We show that labor‐market search implies that financial market integration should increase rather than decrease the fiscal multiplier.