Optimal Fiscal Policy in a Small Open Economy with Incomplete Markets and Interest Rate Shocks
This paper studies optimal fiscal policy in a small open economy model under incomplete financial markets, where interest rates, government spending and productivity are stochastic and taxes are distortionary. The contributions of the paper are twofold. First, I solve the Ramsey problem and characterize the properties of the optimal fiscal policy. Second, I show that the optimal fiscal policy consists in smoothing tax distortions over time. The income tax rate, and the public debt are very persistent irrespective of the degree of autocorrelation of the shocks generating aggregate fluctuations. The government finances an increase in government spending or a decrease in the tax base partly by increasing debt and partly by increasing the tax rate.
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- Correia, Isabel & Neves, Joao C. & Rebelo, Sergio, 1995.
"Business cycles in a small open economy,"
European Economic Review,
Elsevier, vol. 39(6), pages 1089-1113, June.
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- Correia, Isabel & Neves, Joao C & Rebelo, Sérgio, 1994. "Business Cycles in a Small Open Economy," CEPR Discussion Papers 996, C.E.P.R. Discussion Papers.
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- V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
- Chari, V.V. & Kehoe, Patrick J., 1999. "Optimal fiscal and monetary policy," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 26, pages 1671-1745 Elsevier.
- V. V. Chari & Patrick J. Kehoe, 1998. "Optimal fiscal and monetary policy," Staff Report 251, Federal Reserve Bank of Minneapolis.
- V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
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