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Savers, Spenders and Fiscal Policy in a Small Open Economy

  • Egil Matsen
  • Tommy Sveen
  • Ragnar Torvik

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.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1618.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1618
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  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. Jordi Galí & J. David López Salido & Javier Vallés, 2003. "Understanding the effects of government spending on consumption," Banco de Espa�a Working Papers 0321, Banco de Espa�a.
  7. Campbell, John Y. & Mankiw, N. Gregory, 1990. "Permanent Income, Current Income, and Consumption," Scholarly Articles 3353762, Harvard University Department of Economics.
  8. N. Gregory Mankiw, 1999. "The Savers-Spenders Theory of Fiscal Policy," Harvard Institute of Economic Research Working Papers 1888, Harvard - Institute of Economic Research.
  9. 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.
  10. Perotti, Roberto, 2002. "Estimating the effects of fiscal policy in OECD countries," Working Paper Series 0168, European Central Bank.
  11. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Economics Working Papers 015, European Network of Economic Policy Research Institutes.
  12. Rudiger Dornbusch, 1981. "Real Interest Rates, Home Goods, and Optimal External Borrowing," NBER Working Papers 0779, National Bureau of Economic Research, Inc.
  13. repec:fth:harver:1435 is not listed on IDEAS
  14. Boskin, Michael J, 1988. "Consumption, Saving, and Fiscal Policy," American Economic Review, American Economic Association, vol. 78(2), pages 401-07, May.
  15. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October.
  16. Persson, Torsten, 1985. "Deficits and intergenerational welfare in open economies," Journal of International Economics, Elsevier, vol. 19(1-2), pages 67-84, August.
  17. Roberto Perotti, 2004. "Estimating the effects of fiscal policy in OECD countries," Working Papers 276, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
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