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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 Gali & David López-Salido & Javier Valles, 2004. "Understanding the effects of government spending on consumption," International Finance Discussion Papers 805, Board of Governors of the Federal Reserve System (U.S.).
  2. Roberto Perotti, 2005. "Estimating the effects of fiscal policy in OECD countries," Proceedings, Federal Reserve Bank of San Francisco.
  3. Galí, Jordi & Lopez-Salido, Jose David & Vallés Liberal, Javier, 2004. "Rule-of-Thumb Consumers and the Design of Interest Rate Rules," CEPR Discussion Papers 4347, C.E.P.R. Discussion Papers.
  4. N. Gregory Mankiw, 2000. "The Savers-Spenders Theory of Fiscal Policy," NBER Working Papers 7571, National Bureau of Economic Research, Inc.
  5. Campbell, John Y & Mankiw, N Gregory, 1990. "Permanent Income, Current Income, and Consumption," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(3), pages 265-79, July.
  6. Jordi Gali & Tommaso Monacelli, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," NBER Working Papers 8905, National Bureau of Economic Research, Inc.
  7. repec:fth:harver:1435 is not listed on IDEAS
  8. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Economics Working Papers 015, European Network of Economic Policy Research Institutes.
  9. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1329-1368, November.
  10. 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.
  11. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October.
  12. Rudiger Dornbusch, 1981. "Real Interest Rates, Home Goods, and Optimal External Borrowing," NBER Working Papers 0779, National Bureau of Economic Research, Inc.
  13. Torsten Persson, 1983. "Deficits and Intergenerational Welfare in Open Economies," NBER Working Papers 1083, National Bureau of Economic Research, Inc.
  14. 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.
  15. 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.
  16. Perotti, Roberto, 2002. "Estimating the effects of fiscal policy in OECD countries," Working Paper Series 0168, European Central Bank.
  17. Boskin, Michael J, 1988. "Consumption, Saving, and Fiscal Policy," American Economic Review, American Economic Association, vol. 78(2), pages 401-07, May.
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