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Savers, Spenders and Fiscal Policy in a Small Open Economy

Author

Listed:
  • 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)

Abstract

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 endogenous 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 expansionary effect. Although consistent with recent empirical work, this result contrasts with those of most other theoretical models. Transitory changes in demand have permanent 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.

Suggested Citation

  • Egil Matsen & Tommy Sveen & Ragnar Torvik, 2004. "Savers, Spenders and Fiscal Policy in a Small Open Economy," Working Paper 2004/18, Norges Bank.
    • Handle: RePEc:bno:worpap:2004_18
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    References listed on IDEAS

    as
    1. Campbell, John Y. & Mankiw, N. Gregory, 1991. "The response of consumption to income : A cross-country investigation," European Economic Review, Elsevier, vol. 35(4), pages 723-756, May.
    2. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 72(3), pages 707-734.
    3. Boskin, Michael J, 1988. "Consumption, Saving, and Fiscal Policy," American Economic Review, American Economic Association, vol. 78(2), pages 401-407, May.
    4. N. Gregory Mankiw, 2005. "The Savers-Spenders Theory of Fiscal Policy: Corrigendum," American Economic Review, American Economic Association, vol. 95(5), pages 1752-1752, December.
    5. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Economics Working Papers 015, European Network of Economic Policy Research Institutes.
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    7. Dornbusch, Rudiger, 1983. "Real Interest Rates, Home Goods, and Optimal External Borrowing," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 141-153, February.
    8. 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.
    9. Perotti, Roberto, 2002. "Estimating the effects of fiscal policy in OECD countries," Working Paper Series 168, European Central Bank.
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    13. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Niepelt, Dirk, 2014. "Debt maturity without commitment," Journal of Monetary Economics, Elsevier, vol. 68(S), pages 37-54.
    2. Harris Dellas & Dirk Niepelt, 2013. "Credibility For Sale," Working Papers 13.05, Swiss National Bank, Study Center Gerzensee.
    3. Heijdra, Ben J. & Ligthart, Jenny E., 2010. "The Transitional Dynamics Of Fiscal Policy In Small Open Economies," Macroeconomic Dynamics, Cambridge University Press, vol. 14(1), pages 1-28, February.
    4. repec:dau:papers:123456789/179 is not listed on IDEAS
    5. Dirk Niepelt, 2009. "Sovereign Debt Maturity without Commitment," 2009 Meeting Papers 231, Society for Economic Dynamics.
    6. Harris Dellas & Dirk Niepelt, 2021. "Austerity," The Economic Journal, Royal Economic Society, vol. 131(634), pages 697-712.
    7. Gábor P. Kiss, 2007. "One-off and off-budget items: An alternative approach," MNB Conference Volume, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 1(1), pages 18-27, December.

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    Keywords

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    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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