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Stabilization policy, infrastructure investment, and welfare in a small open economy

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  • Germaschewski, Yin

Abstract

Using a two-sector neoclassical growth model in an open economy setting with heterogeneous agents, this paper studies the distributional effects and welfare implications of a joint monetary and fiscal policy response to public infrastructure expansion in emerging market economies. The results show that fiscal stabilization policy is critical for achieving fiscal sustainability and price stability. With joint support of monetary and fiscal policy, government infrastructure investment provides significant welfare gains to the economy, and the choice of fiscal instruments has major distributional effects across agents: saving households accrue the highest welfare gains with new bond issuance, while hand-to-mouth consumers are better off when non-distorting taxes are adjusted. These potential tradeoffs in welfare due to households’ differing responses to infrastructure expansion have important implications for policy making.

Suggested Citation

  • Germaschewski, Yin, 2020. "Stabilization policy, infrastructure investment, and welfare in a small open economy," Economic Modelling, Elsevier, vol. 84(C), pages 322-339.
  • Handle: RePEc:eee:ecmode:v:84:y:2020:i:c:p:322-339
    DOI: 10.1016/j.econmod.2019.04.023
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    Keywords

    Infrastructure investment; Fiscal stabilization; Economic growth of emerging market economies; Welfare;

    JEL classification:

    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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