Optimal Fiscal Policy in a Small Open Economy with Incomplete Markets and Interest Rate Shocks
AbstractThis paper studies optimal fiscal policy in a small open economy model under incomplete financial markets, where interest rates, government spending and productivity are stochastic and taxes are distortionary. The contributions of the paper are twofold. First, I solve the Ramsey problem and characterize the properties of the optimal fiscal policy. Second, I show that the optimal fiscal policy consists in smoothing tax distortions over time. The income tax rate, and the public debt are very persistent irrespective of the degree of autocorrelation of the shocks generating aggregate fluctuations. The government finances an increase in government spending or a decrease in the tax base partly by increasing debt and partly by increasing the tax rate.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Banco de México in its series Working Papers with number 2006-09.
Date of creation: Sep 2006
Date of revision:
optimal fiscal policy; taxation; incomplete markets; debt policy;
Find related papers by JEL classification:
- E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
- F34 - International Economics - - International Finance - - - International Lending and Debt Problems
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
- H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-06-30 (All new papers)
- NEP-CBA-2007-06-30 (Central Banking)
- NEP-DGE-2007-06-30 (Dynamic General Equilibrium)
- NEP-MAC-2007-06-30 (Macroeconomics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Correia, Isabel & Neves, Joao C. & Rebelo, Sergio, 1995.
"Business cycles in a small open economy,"
European Economic Review,
Elsevier, vol. 39(6), pages 1089-1113, June.
- Correia, Maria Isabel Horta & Neves, Joao C & Rebelo, Sérgio, 1994. "Business Cycles in a Small Open Economy," CEPR Discussion Papers 996, C.E.P.R. Discussion Papers.
- Correia, I. & Rabelo, S. & Naves, J.C., 1994. "Business Cycles in a Small Open Economy," RCER Working Papers 382, University of Rochester - Center for Economic Research (RCER).
- V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993.
"Optimal fiscal policy in a business cycle model,"
160, Federal Reserve Bank of Minneapolis.
- V. V. Chari & Patrick J. Kehoe, 1998.
"Optimal fiscal and monetary policy,"
251, Federal Reserve Bank of Minneapolis.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dirección de Sistemas).
If references are entirely missing, you can add them using this form.