In this paper, we use a two country stochastic “new open economy macroeconomics” model with sticky wages and imperfect competition where public spending and private consumption appear in a non-separable way in individual preferences. We use this setup to define optimal fiscal policy in the face of a productivity shock and to analyze the efficiency of this optimal fiscal policy as a stabilization tool. We also consider strategic games between fiscal authorities in the two countries in order to see if there are additional gains from fiscal cooperation. We find that optimal fiscal policy consists of a deviation in the same direction as the deviation of the shock and that this type of reaction reduces the negative effects of the shock. We find also that fiscal cooperation generates a higher level of welfare than under Nash. However, the gain from cooperation is very likely to be negligible.
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Paper provided by Bureau d'Economie Théorique et Appliquée, ULP, Strasbourg in its series Working Papers of BETA with number
2006-09.
Find related papers by JEL classification: 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 F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
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