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Savers, Spenders and Fiscal Policy in a Small Open Economy

  • Egil Matsen

    ()

    (Norwegian University of Science and Technology and Norges Bank)

  • Tommy Sveen

    ()

    (Norges Bank)

  • Ragnar Torvik

    ()

    (Norwegian University of Science and Technology and Norges Bank)

This paper analyzes the effects of fiscal policy in an open economy. We extend the savers-spenders theory of Mankiw (2000) to a small open economy with endoge- nous labor supply. We first show how the Dornbusch (1983) consumption-based real interest rate for open economies is modified when labor supply is endogenous. We then turn to the effects of fiscal policy when there are both savers and spenders. With this heterogeneity taken into account, tax cuts have a short-run contractionary effect on domestic production, and increased public spending has a short-run expan- sionary effect. Although consistent with recent empirical work, this result contrasts with those of most other theoretical models. Transitory changes in demand have per- manent real effects in our model, and we discuss the implications for real exchange- rate dynamics. We also show how "rational" savers may magnify or dampen the responses of "irrational" spenders, and show how this is related to features of the utility functions.

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Paper provided by Norges Bank in its series Working Paper with number 2004/18.

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Length: 28 pages
Date of creation: 29 Dec 2004
Date of revision:
Handle: RePEc:bno:worpap:2004_18
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  1. Jordi Galí & J. David López Salido & Javier Vallés, 2003. "Rule-of-thumb consumers and the design of interest rate rules," Banco de Espa�a Working Papers 0320, Banco de Espa�a.
  2. Jordi Galí & J. David López-Salido & Javier Vallés, 2002. "Understanding the effects of government spending on consumption," Economics Working Papers 911, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2005.
  3. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc.
  4. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October.
  5. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
  6. Galí, Jordi & Monacelli, Tommaso, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," CEPR Discussion Papers 3346, C.E.P.R. Discussion Papers.
  7. Boskin, Michael J, 1988. "Consumption, Saving, and Fiscal Policy," American Economic Review, American Economic Association, vol. 78(2), pages 401-07, May.
  8. Rudiger Dornbusch, 1981. "Real Interest Rates, Home Goods, and Optimal External Borrowing," NBER Working Papers 0779, National Bureau of Economic Research, Inc.
  9. Perotti, Roberto, 2002. "Estimating the effects of fiscal policy in OECD countries," Working Paper Series 0168, European Central Bank.
  10. N. Gregory Mankiw, 1999. "The Savers-Spenders Theory of Fiscal Policy," Harvard Institute of Economic Research Working Papers 1888, Harvard - Institute of Economic Research.
  11. Campbell, John Y. & Mankiw, N. Gregory, 1990. "Permanent Income, Current Income, and Consumption," Scholarly Articles 3353762, Harvard University Department of Economics.
  12. Roberto Perotti, 2004. "Estimating the effects of fiscal policy in OECD countries," Working Papers 276, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  13. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Economics Working Papers 015, European Network of Economic Policy Research Institutes.
  14. Poterba, James M, 1988. "Are Consumers Forward Looking? Evidence from Fiscal Experiments," American Economic Review, American Economic Association, vol. 78(2), pages 413-18, May.
  15. Torsten Persson, 1983. "Deficits and Intergenerational Welfare in Open Economies," NBER Working Papers 1083, National Bureau of Economic Research, Inc.
  16. repec:fth:harver:1435 is not listed on IDEAS
  17. Edward N. Wolff, 1998. "Recent Trends in the Size Distribution of Household Wealth," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 131-150, Summer.
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