Fiscal Policy in Open, Interdependent Economies
The paper studies the effects of alternative financing policies in the open economy. There is a non-trivial role for financing policy because of the failure of first-order debt neutrality due to uncertain private lifetimes. Both the single-country case and the interdependent two-country case are considered. Capital formation is endogenous and there are unified global financial and goods markets determining the interest rate, each country's "Tobin's q" and the terms of trade. The government's present value budget constraint or solvency constraint and the assumption that the interest rate exceeds the growth rate imply that, given spending, current tax cuts imply future tax increases. Such policies boost the outstanding stock of public debt, raise the world interest rate, crowd out capital formation at home and abroad, and lead to a loss of foreign assets. Provided a "supply-side-response-corrected" transfer criterion is satisfied, the terms of trade will improve in the short run and worsen in the long run.
|Date of creation:||Sep 1984|
|Date of revision:|
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- Barro, Robert J., 1979.
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- Miller, Marcus & Salmon, Mark, 1983. "Dynamic Games and the Time Inconsistency of Optimal Policy in Open Economies," The Warwick Economics Research Paper Series (TWERPS) 232, University of Warwick, Department of Economics.
- Miller, Marcus & Salmon, Mark, 1984. "Dynamic Games and the Time Inconsistency of Optimal Policy in Open Economies," CEPR Discussion Papers 27, C.E.P.R. Discussion Papers.
- Jacob A. Frenkel & Assaf Razin, 1984. "Fiscal Policies, Debt, and International Economic Interdependence," NBER Working Papers 1266, National Bureau of Economic Research, Inc.
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