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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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File URL: http://eprints.lse.ac.uk/28515/
File Function: Open access version.
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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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Web page: http://www.lse.ac.uk/

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  1. Jordi Gali & Tommaso Monacelli, 2005. "Optimal Monetary and Fiscal Policy in a Currency Union," NBER Working Papers 11815, National Bureau of Economic Research, Inc.
  2. Beetsma, Roel & Jensen, Henrik, 2002. "Monetary and fiscal policy interactions in a micro-founded model of a monetary union," Working Paper Series 0166, European Central Bank.
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  4. Bianca De Paoli, 2004. "Monetary Policy and Welfare in a Small Open Economy," CEP Discussion Papers dp0639, Centre for Economic Performance, LSE.
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  8. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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  13. Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Optimal Fiscal and Monetary Policy Under Sticky Prices," CEPR Discussion Papers 2942, C.E.P.R. Discussion Papers.
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  18. Lombardo, Giovanni & Sutherland, Alan, 2003. "Monetary and fiscal interactions in open economies," Working Paper Series 0289, European Central Bank.
  19. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  20. 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.
  21. Obstfeld, Maurice & Rogoff, Kenneth, 2001. "Global Implications of Self-Orientated National Monetary Rules," CEPR Discussion Papers 2856, C.E.P.R. Discussion Papers.
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  24. 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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