Optimal Fiscal Policy in a Small Open Economy and the Structure of International Financial Markets
AbstractThis paper characterizes the behavior of debt and tax rates in a small open economy under both complete and incomplete markets. First, I show hat when the government follows an optimal fiscal policy and agents have access to complete markets, the value of the government’s debt portfolio is negatively correlated with government spending, and positively correlated with productivity and output, while output, labor, consumption and the tax rate are uncorrelated with government spending shocks. The stochastic processes followed by these variables inherit the serial-correlation properties of the stochastic process of the productivity shock. Second, I show that if agents can only buy and sell one-period risk-free bonds, public debt shows more persistence than other variables, and it is negatively correlated with productivity and output, and positively correlated with government spending. Moreover, the tax rate is positively correlated with government spending, while consumption is negatively correlated.
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Bibliographic InfoPaper provided by Banco de México in its series Working Papers with number 2007-07.
Date of creation: Mar 2007
Date of revision:
Complete markets; Incomplete markets; Optimal fiscal 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
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- 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)
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