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On the international dimension of fiscal policy

  • Gianluca Benigno
  • Bianca De Paoli

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 London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 28515.

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Length: 39 pages
Date of creation: Jan 2009
Date of revision:
Handle: RePEc:ehl:lserod:28515
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  1. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 519-39, August.
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  7. Galí, Jordi & Monacelli, Tommaso, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," CEPR Discussion Papers 3346, C.E.P.R. Discussion Papers.
  8. Andrea Ferrero, 2005. "Fiscal and Monetary Rules for a Currency Union," Macroeconomics 0508020, EconWPA.
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  12. Bianca De Paoli, 2004. "Monetary policy and welfare in a small open economy," LSE Research Online Documents on Economics 19950, London School of Economics and Political Science, LSE Library.
  13. 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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  20. repec:oup:qjecon:v:117:y:2002:i:2:p:503-535 is not listed on IDEAS
  21. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
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