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Structural and Stabilization Aspects of Fiscal and Financial Policy in the Dependent Economy

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  • Willem H. Buiter

Abstract

The paper considers the response of a small, open dependent economy to a variety of fiscal and financial shocks as well as the influence of alternative budget balancing rules on the response of the system to such external shocks as a change in the world interest rate. The approach allows for both uncertain individual lifetimes and population growth, using a slightly generalized version of the Yaari-Blanchard model of consumer behavior. Debt neutrality does not prevail unless the sum of the population growth rate and the individual's probability of death equals zero. The government spends on traded and non-traded goods and raises tax revenue both through a lump sum tax and through a distortionary tax on the production of traded goods. Even though the tax on the production of traded goods is the only conventional distortion in the model, changes in this tax rate will have first order real income effects even when the distortion is evaluated at a zero tax rate, as long as the individual's subjective pure rate of time preference differs from the interest rate. This can occur even in well-behaved steady states of the Yaari-Blanchard model, as long as the population growth rate plus the probability of death differ from zero. This "intrinsic" distortion effectively causes second-best arguments to apply even when there is only one conventional distortion. Even in the absence of government budget deficits, fiscal choices relating to the composition of public spending and the structure of taxation have important short-term and long-term consequences for the real exchange rate, the sectoral allocation of production, the level and composition of private consumption, the current account (in the short run) and the nation's stock of claims on the rest of the world in the long run.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2023.

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Date of creation: Sep 1986
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Publication status: published as Oxford Economic Papers, Vol. 40, No. 2, pp. 220-245, (June 1988).
Handle: RePEc:nbr:nberwo:2023

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  1. Buiter, Willem H, 1984. "Saddlepoint Problems in Continuous Time Rational Expectations Models: A General Method and Some Macroeconomic Examples," Econometrica, Econometric Society, Econometric Society, vol. 52(3), pages 665-80, May.
  2. T. W.Swan, 1960. "Economic Control In A Dependent Economy," The Economic Record, The Economic Society of Australia, vol. 36(73), pages 51-66, 03.
  3. Jacob A. Frenkel & Assaf Razin, 1984. "Fiscal Policies, Debt, and International Economic Interdependence," NBER Working Papers 1266, National Bureau of Economic Research, Inc.
  4. W. E. G. Salter, 1959. "Internal And External Balance: The Role Op Price And Expenditure Effects," The Economic Record, The Economic Society of Australia, vol. 35(71), pages 226-238, 08.
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Cited by:
  1. Jacob A. Frenkel & Assaf Razin, 1986. "Fiscal Policies and Real Exchange Rates in the World Economy," NBER Working Papers 2065, National Bureau of Economic Research, Inc.
  2. Steigum, E. & Thogersen, O., 1998. "Borrow and Adjust. Fiscal Policy and Sectoral Adjustment in an Open Economy," Papers, Norwegian School of Economics and Business Administration- 28/98, Norwegian School of Economics and Business Administration-.
  3. Buiter, Willem H, 1988. "Some Thoughts on the Role of Fiscal Policy in Stabilization and Structural Adjustment in Developing Countries," CEPR Discussion Papers 260, C.E.P.R. Discussion Papers.
  4. Willem H. Buiter, 1988. "Centre For Labour Economics," NBER Working Papers 2578, National Bureau of Economic Research, Inc.
  5. Buiter, Willem H, 1988. "Can Public Spending Cuts be Inflationary?," CEPR Discussion Papers 225, C.E.P.R. Discussion Papers.
  6. Massimo Antonini, 2005. "Public Capital, Fiscal Deficit and Growth," DEGIT Conference Papers c010_055, DEGIT, Dynamics, Economic Growth, and International Trade.
  7. Dai, Meixing, 1992. "Growth, External Debt Constraints and Budgetary Policies," MPRA Paper 14001, University Library of Munich, Germany.

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