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Fiscal Policy and the Current Account in a Small Open Economy

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  • Juha Tervala

    () (University of Helsinki, Department of Economics, Finland)

Abstract

This paper analyses the macroeconomic effects of fiscal policy in a small open economy in a flexible exchange rate regime. The key result is that the effects of fiscal policy depend on the size of the elasticity of substitution between traded and nontraded goods. In particular, the sign of the current account response to fiscal policy depends on the interplay between the intertemporal elasticity of aggregate consumption and the elasticity of substitution between traded and nontraded goods. The paper also shows that only permanent fiscal expansions generate current account imbalances while temporary fiscal expansions do not affect the current account.

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Bibliographic Info

Article provided by Finnish Economic Association in its journal Finnish Economic Papers.

Volume (Year): 20 (2007)
Issue (Month): 2 (Autumn)
Pages: 108-120

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Handle: RePEc:fep:journl:v:20:y:2007:i:2:p:108-120

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Web page: http://www.taloustieteellinenyhdistys.fi
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  1. Jonathan D. Ostry & Carmen M. Reinhart, 1992. "Private Saving and Terms of Trade Shocks: Evidence from Developing Countries," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 495-517, September.
  2. S. Rao Aiyagari & Lawrence J. Christiano & Martin Eichenbaum, 1990. "The Output, Employment, and Interest Rate Effects of Government Consumption," NBER Working Papers 3330, National Bureau of Economic Research, Inc.
  3. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-34, June.
  4. Maurice Obstfeld & Kenneth Rogoff, 2004. "The Unsustainable US Current Account Position Revisited," NBER Working Papers 10869, National Bureau of Economic Research, Inc.
  5. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-60, June.
  6. Dornbusch, Rudiger, 1983. "Real Interest Rates, Home Goods, and Optimal External Borrowing," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 141-53, February.
  7. Maurice Obstfeld & Kenneth S. Rogoff, 2005. "Global Current Account Imbalances and Exchange Rate Adjustments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(1), pages 67-146.
  8. Reinhart, Carmen & Ostry, Jonathan, 1992. "Saving and Terms of Trade Shocks: Evidence from Developing Countries," MPRA Paper 6976, University Library of Munich, Germany.
  9. Julio J. Rotemberg & Michael Woodford, 1989. "Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity," NBER Working Papers 3206, National Bureau of Economic Research, Inc.
  10. Selma Mahfouz & Richard Hemming & Michael Kell, 2002. "The Effectiveness of Fiscal Policy in Stimulating Economic Activity-A Review of the Literature," IMF Working Papers 02/208, International Monetary Fund.
  11. Hall, Robert E., 1980. "Labor supply and aggregate fluctuations," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 12(1), pages 7-33, January.
  12. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  13. Alan C. Stockman & Linda L. Tesar, 1991. "Tastes and technology in a two-country model of the business cycle: explaining international co-movements," Working Paper 9019, Federal Reserve Bank of Cleveland.
  14. Philip R. Lane & Giovanni Ganelli, 2002. "Dynamic General Equilibrium Analysis: The Open Economy Dimension," Trinity Economics Papers 200212, Trinity College Dublin, Department of Economics.
  15. Cedric Tille, 1999. "The role of consumption substitutability in the international transmission of shocks," Staff Reports 67, Federal Reserve Bank of New York.
  16. Soyoung Kim & Nouriel Roubini, 2004. "Twin Deficit or Twin Divergence? Fiscal Policy, Current Account, and Real Exchange Rate in the US," Econometric Society 2004 North American Winter Meetings 271, Econometric Society.
  17. Mankiw, N Gregory & Summers, Lawrence H, 1986. "Money Demand and the Effects of Fiscal Policies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(4), pages 415-29, November.
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Cited by:
  1. Darius, Reginald, 2010. "The macroeconomic effects of monetary and fiscal policy in a small open economy: Does the exchange rate regime matter?," Journal of International Money and Finance, Elsevier, vol. 29(8), pages 1508-1528, December.

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