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Structural and Stabilization Aspects of Fiscal and Financial Policy in the Dependent Economy

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  • Buiter, Willem H.

Abstract

The paper considers the response of a small, open dependent economy to a variety of fiscal and financial shocks. It also examines the influence of alternative budget-balancing rules on the response of the economy to external shocks, such as a change in the world interest rate. The approach allows for both uncertain individual lifetimes and population growth, using a slightly generalized version of the Yaari-Blanchard model of consumer behaviour. Debt neutrality does not prevail unless the sum of the population growth rate and the individual's probability of death equals zero. The government spends on traded and non-traded goods and raises tax revenue both through a lump sum tax and through a distortionary tax on the production of traded goods. Even though the tax on the production of traded goods is the only conventional distortion in the model, changes in this tax rate will have first-order real income effects even when the distortion is evaluated at a zero tax rate, as long as the individual's subjective pure rate of time preference differs from the interest rate. This can occur even in well-behaved steady states of the Yaari-Blanchard model, as long as the sum of population growth rate and the probability of death differs from zero. This "intrinsic" distortion effectively causes second-best arguments to apply even when there is only one conventional distortion. Even in the absence of government budget deficits, fiscal choices relating to the composition of public spending and the structure of taxation have important short- and long-term consequences for the real exchange rate, the sectoral allocation of production, and the level and composition of private consumption. They also affect the current account in the short run and the nation's stock of claims on the rest of the world in the long run.

Suggested Citation

  • Buiter, Willem H., 1986. "Structural and Stabilization Aspects of Fiscal and Financial Policy in the Dependent Economy," CEPR Discussion Papers 128, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:128
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    References listed on IDEAS

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    1. Buiter, Willem H, 1984. "Saddlepoint Problems in Continuous Time Rational Expectations Models: A General Method and Some Macroeconomic Examples," Econometrica, Econometric Society, vol. 52(3), pages 665-680, May.
    2. Jacob A. Frenkel & Assaf Razin, 1984. "Fiscal Policies, Debt, and International Economic Interdependence," NBER Working Papers 1266, National Bureau of Economic Research, Inc.
    3. W. E. G. Salter, 1959. "Internal And External Balance: The Role Op Price And Expenditure Effects," The Economic Record, The Economic Society of Australia, vol. 35(71), pages 226-238, August.
    4. T. W.Swan, 1960. "Economic Control In A Dependent Economy," The Economic Record, The Economic Society of Australia, vol. 36(73), pages 51-66, March.
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    Citations

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    Cited by:

    1. Willem H. Buiter, 1988. "Centre For Labour Economics," NBER Working Papers 2578, National Bureau of Economic Research, Inc.
    2. Jacob A. Frenkel & Assaf Razin, 1986. "Fiscal Policies and Real Exchange Rates in the World Economy," NBER Working Papers 2065, National Bureau of Economic Research, Inc.
    3. Erling Steigum & Øystein Thøgersen, 2003. "Borrow and Adjust: Fiscal Policy and Sectoral Adjustment in an Open Economy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(2), pages 699-724, May.
    4. Antonis Adam & Panos Hatzipanayotou & Thomas Moutos, 2015. "Labour Market Regulation, Fiscal Consolidation, and the Success of Current Account Adjustments," DEOS Working Papers 1517, Athens University of Economics and Business.
    5. Antonis Adam & Thomas Moutos, 2017. "The Modality of Fiscal Consolidation and Current Account Adjustment," CESifo Economic Studies, CESifo, vol. 63(2), pages 162-181.
    6. Buiter, Willem H., 1988. "Can Public Spending Cuts be Inflationary?," CEPR Discussion Papers 225, C.E.P.R. Discussion Papers.
    7. Dai, Meixing, 1992. "Growth, External Debt Constraints and Budgetary Policies," MPRA Paper 14001, University Library of Munich, Germany.
    8. Camelia, BALTARETU, 2016. "A Review Of Theoretical Approaches About Seigniorage," Contemporary Economy Journal, Constantin Brancoveanu University, vol. 1(1), pages 82-88.
    9. Buiter, W.H., 1988. "Some Thoughts On The Role Of Fiscal Policy In Stabilisation And Structural Adjustment In Developing Countries," Papers 312, London School of Economics - Centre for Labour Economics.
    10. Massimo Antonini, 2005. "Public Capital, Fiscal Deficit and Growth," DEGIT Conference Papers c010_055, DEGIT, Dynamics, Economic Growth, and International Trade.

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