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Fiscal Policy in Open, Interdependent Economies

  • Buiter, Willem H.

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 28.

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Date of creation: Sep 1984
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Handle: RePEc:cpr:ceprdp:28
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  1. Jacob A. Frenkel & Assaf Razin, 1984. "Fiscal Policies, Debt, and International Economic Interdependence," NBER Working Papers 1266, National Bureau of Economic Research, Inc.
  2. Jacob A. Frenkel & Assaf Razin, 1986. "Budget Deficits and Rates of Interest in the World Economy," NBER Working Papers 1354, National Bureau of Economic Research, Inc.
  3. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  4. Willem H. Buiter, 1979. "Time Preference and International Lending and Borrowing in an Overlapping-Generations Model," NBER Working Papers 0352, National Bureau of Economic Research, Inc.
  5. Svensson, Lars E O & Razin, Assaf, 1983. "The Terms of Trade and the Current Account: The Harberger-Laursen-Metzler Effect," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 97-125, February.
  6. 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.
  7. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
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