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Savers, Spenders and Fiscal Policy in a Small Open Economy

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Author Info
Egil Matsen ()
Tommy Sveen ()
Ragnar Torvik ()

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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 endogenous 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 expansionary effect. Although consistent with recent empirical work, this result contrasts with those of most other theoretical models. Transitory changes in demand have permanent 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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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 1618.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1618

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

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Find related papers by JEL classification:
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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References listed on IDEAS
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  1. Wolff, Edward N, 1998. "Recent Trends in the Size Distribution of Household Wealth," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 131-50, Summer. [Downloadable!] (restricted)
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    Other versions:
  4. Persson, Torsten, 1985. "Deficits and intergenerational welfare in open economies," Journal of International Economics, Elsevier, vol. 19(1-2), pages 67-84, August. [Downloadable!] (restricted)
    Other versions:
  5. 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. [Downloadable!]
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  6. Jordi Galí & Tommaso Monacelli, 2004. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Economics Working Papers 835, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
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  7. Jordi Galí & J. David López Salido & Javier Vallés, 2003. "Understanding the effects of government spending on consumption," Banco de España Working Papers 0321, Banco de España. [Downloadable!]
  8. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August. [Downloadable!] (restricted)
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  9. Boskin, Michael J, 1988. "Consumption, Saving, and Fiscal Policy," American Economic Review, American Economic Association, vol. 78(2), pages 401-07, May. [Downloadable!] (restricted)
  10. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Working Paper Series 168, European Central Bank. [Downloadable!]
  11. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1329-1368, November. [Downloadable!] (restricted)
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  12. Jordi Galí & J. David López-Salido & Javier Vallés, 2007. "Understanding the Effects of Government Spending on Consumption," Journal of the European Economic Association, MIT Press, vol. 5(1), pages 227-270, 03. [Downloadable!] (restricted)
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  13. 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.
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  14. N. Gregory Mankiw, 2000. "The Savers-Spenders Theory of Fiscal Policy," American Economic Review, American Economic Association, vol. 90(2), pages 120-125, May. [Downloadable!] (restricted)
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  15. Perotti, Roberto, 2005. "Estimating the Effects of Fiscal Policy in OECD Countries," CEPR Discussion Papers 4842, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  16. Roberto Perotti, 2005. "Estimating the effects of fiscal policy in OECD countries," Proceedings, Federal Reserve Bank of San Francisco. [Downloadable!]
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  17. 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. [Downloadable!] (restricted)
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  18. Galí, Jordi & Lopez-Salido, Jose David & Vallés Liberal, Javier, 2004. "Rule-of-Thumb Consumers and the Design of Interest Rate Rules," CEPR Discussion Papers 4347, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  19. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Economics Working Papers 015, European Network of Economic Policy Research Institutes. [Downloadable!]
  20. 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. [Downloadable!] (restricted)
  21. repec:fth:harver:1435 is not listed on IDEAS
  22. Haltiwanger, John C & Waldman, Michael, 1989. "Limited Rationality and Strategic Complements: The Implications for Macroeconomics," The Quarterly Journal of Economics, MIT Press, vol. 104(3), pages 463-83, August. [Downloadable!] (restricted)
  23. 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.
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  24. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October. [Downloadable!] (restricted)
  25. 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.). [Downloadable!]
  26. Haltiwanger, John & Waldman, Michael, 1985. "Rational Expectations and the Limits of Rationality: An Analysis of Heterogeneity," American Economic Review, American Economic Association, vol. 75(3), pages 326-40, June. [Downloadable!] (restricted)
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Cited by:
(explanations, 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.)

  1. Dirk Niepelt, 2008. "Debt Maturity without Commitment," Working Papers 08.05, Swiss National Bank, Study Center Gerzensee. [Downloadable!]
    Other versions:
  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. [Downloadable!]
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