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Fiscal Policy and the Current Account in a Small Open Economy

  • Juha Tervala


    (University of Helsinki, Department of Economics, Finland)

This paper analyses the macroeconomic effects of fiscal policy in a small open economy in a flexible exchange rate regime. The key result is that the effects of fiscal policy depend on the size of the elasticity of substitution between traded and nontraded goods. In particular, the sign of the current account response to fiscal policy depends on the interplay between the intertemporal elasticity of aggregate consumption and the elasticity of substitution between traded and nontraded goods. The paper also shows that only permanent fiscal expansions generate current account imbalances while temporary fiscal expansions do not affect the current account.

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Article provided by Finnish Economic Association in its journal Finnish Economic Papers.

Volume (Year): 20 (2007)
Issue (Month): 2 (Autumn)
Pages: 108-120

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Handle: RePEc:fep:journl:v:20:y:2007:i:2:p:108-120
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  1. S. Rao Aiyagari & Lawrence J. Christiano & Martin Eichenbaum, 1990. "The Output, Employment, and Interest Rate Effects of Government Consumption," NBER Working Papers 3330, National Bureau of Economic Research, Inc.
  2. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-85, March.
  3. Lane, P.R. & Ganelli, G., 2002. "Dynamic General Equilibrium Analysis: The Open Economy Dimension," CEG Working Papers 20026, Trinity College Dublin, Department of Economics.
  4. Julio J. Rotemberg & Michael Woodford, 1989. "Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity," NBER Working Papers 3206, National Bureau of Economic Research, Inc.
  5. 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.
  6. Obstfeld, Maurice & Rogoff, Kenneth S., 1995. "Exchange Rate Dynamics Redux," Scholarly Articles 12491026, Harvard University Department of Economics.
  7. King, R.G. & Baxter, M., 1990. "Fiscal Policy In General Equilibrium," RCER Working Papers 244, University of Rochester - Center for Economic Research (RCER).
  8. Maurice Obstfeld & Kenneth Rogoff, 2005. "The unsustainable U.S. current account position revisited," Proceedings, Federal Reserve Bank of San Francisco, issue Feb.
  9. Cedric Tille, 1999. "The role of consumption substitutability in the international transmission of shocks," Staff Reports 67, Federal Reserve Bank of New York.
  10. Jonathan D. Ostry & Carmen M. Reinhart, 1992. "Private Saving and Terms of Trade Shocks: Evidence from Developing Countries," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 495-517, September.
  11. 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.
  12. Selma Mahfouz & Richard Hemming & Michael Kell, 2002. "The Effectiveness of Fiscal Policy in Stimulating Economic Activity: A Review of the Literature," IMF Working Papers 02/208, International Monetary Fund.
  13. Kenneth Rogoff & William Brainard & George Perry, . "Global Current Account Imbalances and Exchange Rate Adjustments," Working Paper 33687, Harvard University OpenScholar.
  14. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  15. Robert E. Hall, 1979. "Labor Supply and Aggregate Fluctuations," NBER Working Papers 0385, National Bureau of Economic Research, Inc.
  16. Mankiw, N Gregory & Summers, Lawrence H, 1986. "Money Demand and the Effects of Fiscal Policies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(4), pages 415-29, November.
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