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Investment Tax Credit in an Open Economy with External Debt and Imperfect Capital Mobility *
Author(s) -
ASSIBEYYEBOAH MARK,
MOHSIN MOHAMMED
Publication year - 2011
Publication title -
economic record
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.365
H-Index - 42
eISSN - 1475-4932
pISSN - 0013-0249
DOI - 10.1111/j.1475-4932.2011.00732.x
Subject(s) - monetary economics , economics , external debt , small open economy , investment (military) , debt , current account , imperfect , debt to gdp ratio , internal debt , macroeconomics , exchange rate , politics , law , political science , linguistics , philosophy
In this article, we examine the effects of an investment tax credit (ITC) in a small, open, developing economy with external debt and sovereign risk. The risk premium on foreign loans depends on the debt–income ratio. We show that an increase in the rate of an ITC leads to an increase in aggregate consumption, capital accumulation, foreign debt and output in the long run. Despite the fact that there is insignificant long‐run effect, employment exhibits significant transitional dynamics. Moreover, our results show that the accumulation of foreign debt exhibits non‐monotonic adjustment. Particularly, an increase in the ITC leads to a current account deficit followed by a surplus. Along with this non‐monotonicity, our model also explains the positive correlation between savings and investment during the transitional periods. We have also worked out the effects of temporary ITC policies.