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Savers, Spenders and Fiscal Policy in a Small Open Economy

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  • Egil Matsen

    ()
    (Norwegian University of Science and Technology and Norges Bank)

  • Tommy Sveen

    ()
    (Norges Bank)

  • Ragnar Torvik

    ()
    (Norwegian University of Science and Technology and Norges Bank)

Abstract

This paper analyzes the effects of fiscal policy in an open economy. We extend the savers-spenders theory of Mankiw (2000) to a small open economy with endoge- nous labor supply. We first show how the Dornbusch (1983) consumption-based real interest rate for open economies is modified when labor supply is endogenous. We then turn to the effects of fiscal policy when there are both savers and spenders. With this heterogeneity taken into account, tax cuts have a short-run contractionary effect on domestic production, and increased public spending has a short-run expan- sionary effect. Although consistent with recent empirical work, this result contrasts with those of most other theoretical models. Transitory changes in demand have per- manent real effects in our model, and we discuss the implications for real exchange- rate dynamics. We also show how "rational" savers may magnify or dampen the responses of "irrational" spenders, and show how this is related to features of the utility functions.

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Bibliographic Info

Paper provided by Norges Bank in its series Working Paper with number 2004/18.

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Length: 28 pages
Date of creation: 29 Dec 2004
Date of revision:
Handle: RePEc:bno:worpap:2004_18

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Keywords: rule-of-thumb consumers; fiscal policy; open economy;

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References

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  1. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc.
  2. Rudiger Dornbusch, 1981. "Real Interest Rates, Home Goods, and Optimal External Borrowing," NBER Working Papers 0779, National Bureau of Economic Research, Inc.
  3. J. Galí & D. López-Salido & J. Vallés, 2003. "Understanding the effects of government spending on consumption," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  4. repec:fth:harver:1435 is not listed on IDEAS
  5. Poterba, James M, 1988. "Are Consumers Forward Looking? Evidence from Fiscal Experiments," American Economic Review, American Economic Association, vol. 78(2), pages 413-18, May.
  6. N. Gregory Mankiw, 2000. "The Savers-Spenders Theory of Fiscal Policy," American Economic Review, American Economic Association, vol. 90(2), pages 120-125, May.
  7. Boskin, Michael J, 1988. "Consumption, Saving, and Fiscal Policy," American Economic Review, American Economic Association, vol. 78(2), pages 401-07, May.
  8. Jordi Galí & J. David López Salido & Javier Vallés, 2003. "Rule-of-thumb consumers and the design of interest rate rules," Banco de Espa�a Working Papers 0320, Banco de Espa�a.
  9. Edward N. Wolff, 1998. "Recent Trends in the Size Distribution of Household Wealth," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 131-150, Summer.
  10. Roberto Perotti, 2005. "Estimating the effects of fiscal policy in OECD countries," Proceedings, Federal Reserve Bank of San Francisco.
  11. Jeffery D. Amato & Thomas Laubach, 2002. "Rule-of-thumb behaviour and monetary policy," Finance and Economics Discussion Series 2002-5, Board of Governors of the Federal Reserve System (U.S.).
  12. Torsten Persson, 1983. "Deficits and Intergenerational Welfare in Open Economies," NBER Working Papers 1083, National Bureau of Economic Research, Inc.
  13. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Economics Working Papers 015, European Network of Economic Policy Research Institutes.
  14. Galí, Jordi & Monacelli, Tommaso, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," CEPR Discussion Papers 3346, C.E.P.R. Discussion Papers.
  15. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
  16. Campbell, John Y & Mankiw, N Gregory, 1990. "Permanent Income, Current Income, and Consumption," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(3), pages 265-79, July.
  17. Perotti, Roberto, 2002. "Estimating the effects of fiscal policy in OECD countries," Working Paper Series 0168, European Central Bank.
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Cited by:
  1. Francoise Forges & Frederic Koessler, 2006. "Long Persuasion Games," THEMA Working Papers 2006-01, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  2. Gábor P. Kiss, 2007. "One-off and off-budget items: An alternative approach," MNB Conference Volume, Magyar Nemzeti Bank (the central bank of Hungary), vol. 1(1), pages 18-27, December.
  3. Harris Dellas & Dirk Niepelt, 2013. "Credibility for Sale," CESifo Working Paper Series 4335, CESifo Group Munich.
  4. Dirk Niepelt, 2009. "Sovereign Debt Maturity without Commitment," 2009 Meeting Papers 231, Society for Economic Dynamics.
  5. Niepelt, Dirk, 2008. "Debt Maturity without Commitment," CEPR Discussion Papers 7093, C.E.P.R. Discussion Papers.

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