Essays on capital mobility and investment (Mexico)

This dissertation has two parts. One dealing with capital mobility and optimal current account determination, and the second with the role of fiscal policy on expectations and investment. The first part is Chapter 1, and the second consists of Chapters 2 and 3.; The first part extends the literature on the determination of the current account by considering the presence of non-tradable goods. Existing studies view the current account as a mechanism for smoothing aggregate consumption over time. However, previous work attribute an extremely high consumption-smoothing ability to the current account by implicitly assuming that all goods can be traded internationally or perfect substitutability in either consumption or production of tradables and non-tradables is possible. I show that previous studies miss an important point in the characterization of the current account's behavior by failing to consider the presence of non-tradables. A large share of non-tradable goods is found in many economies, implying that a reduced ability of the current account to smooth consumption is present in many cases. I relax the assumption that all goods are homogeneous and explore the role of imperfect substitutability among tradable and non-tradable goods. A two-sector version of the Sachs (1982) model, with one sector of non-tradables is constructed, estimated, and tested for the case of Mexico in the period 1980–1998 using the Campbell and Shiller (1987) econometric methodology. I conclude that there is no evidence of imperfect capital mobility for the case of Mexico under the two-sector model.; Chapter 2 studies the impact of current tax policy on investment via expectations about future taxes. A model of signaling is developed to show that output fluctuations should be considered when the credibility of the current fiscal policy as a signal is evaluated. When negative supply shocks hit, a government may not reveal its preference for high taxation. However, when supply shocks are positive and the tax base is expanded, a government may find this false signal too costly due to the increased revenue given up. The bottom line is that the tax strategy is changed by the size of the current tax base, which in turn is affected by supply shocks.; The third Chapter explores the experience of selected OECD countries that undertook fiscal reforms during the 1980s, in order to find evidence of the expectations effect linking fiscal policy to investment. Accordingly, a tax cut can have a second-order effect in promoting investment by inducing positive expectations about future tax rates, conditional on the business cycle and the government's budgetary position. A case-study approach describing the country-specific conditions under which tax reforms were implemented suggests that, in some cases, the surge in investment in the aftermath of tax cut announcements can be explained by the expectations effect considered. This finding is corroborated by a regression analysis, aimed at capturing the effect of expectations on investment after controlling for variations in the real interest rate.