A small open economy is characterized by a two-sector model with tradables and non-tradables. Stabilization policies typically have unequal effects on these two sectors and expansion of total output often requires contraction in one sector. Such situations make difficult obtaining effective consensus on the appropriate stabilization policy. Expansionary fiscal policy requires a contraction in one sector after the labour market adjusts to the disturbance; monetary policy is ineffective under fixed exchange rates and may not have sectoral conflict under flexible exchange rates. Sectoral conflict can be eliminated by designing policy combinations that maintain a given relative price of nontradables.
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Paper provided by Queen's University, Department of Economics in its series Working Papers with number
364.