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On the International Dimension of Fiscal Policy

  • Benigno, Gianluca
  • De Paoli, Bianca

This paper analyses the international dimension of fiscal policy using a small open economy framework in which the government finances its spending by levying distortionary taxation and issuing non-state-contingent debt. The main finding of the paper is that, once the open economy aspect of the policy problem is considered, it is not optimal to smooth taxes following idiosyncratic shocks. Even when prices are flexible and inflation can costlessly act as a shock absorber to restore fiscal equilibrium, the presence of a terms of trade externality lead to movements in the tax rate. Also in contrast with the closed economy, the introduction of sticky prices, can reduce the optimal volatility of taxes.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7232.

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Date of creation: Mar 2009
Date of revision:
Handle: RePEc:cpr:ceprdp:7232
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  1. Bernardino Adão & Isabel Horta Correia & Pedro Teles, 2006. "On the Relevance of Exchange Rate Regimes for Stabilization Policy," Working Papers w200616, Banco de Portugal, Economics and Research Department.
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  6. Andrea Ferrero, 2005. "Fiscal and Monetary Rules for a Currency Union," Macroeconomics 0508020, EconWPA.
  7. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under sticky prices," Journal of Economic Theory, Elsevier, vol. 114(2), pages 198-230, February.
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  9. Pierpaolo Benigno & Michael Woodford, 2005. "Inflation Stabilization And Welfare: The Case Of A Distorted Steady State," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1185-1236, December.
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  13. Lombardo, Giovanni & Sutherland, Alan, 2003. "Monetary and fiscal interactions in open economies," Working Paper Series 0289, European Central Bank.
  14. Bianca De Paoli, 2004. "Monetary Policy and Welfare in a Small Open Economy," CEP Discussion Papers dp0639, Centre for Economic Performance, LSE.
  15. Cedric Tille, 1999. "The role of consumption substitutability in the international transmission of shocks," Staff Reports 67, Federal Reserve Bank of New York.
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  21. repec:oup:qjecon:v:117:y:2002:i:2:p:503-535 is not listed on IDEAS
  22. Alan Sutherland, 2002. "A Simple Second-Order Solution Method for Dynamic General Equilibrium Models," Discussion Paper Series, Department of Economics 200211, Department of Economics, University of St. Andrews.
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  25. Robert Kollmann, 2004. "Welfare Maximizing Monetary and Fiscal Policy Rules," Computing in Economics and Finance 2004 102, Society for Computational Economics.
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