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Efficient expropriation: sustainable fiscal policy in a small open economy

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  • Mark Aguiar
  • Manuel Amador
  • Gita Gopinath

Abstract

We study a small open economy characterized by two empirically important frictions— incomplete financial markets and an inability of the government to commit to policy. We characterize the best sustainable fiscal policy and show that it can amplify and prolong shocks to output. In particular, even when the government is completely benevolent, the government’s credibility not to expropriate capital varies endogenously with the state of the economy and may be “scarcest” during recessions. This increased threat of expropriation depresses investment, prolonging downturns. It is the incompleteness of financial markets and the lack of commitment that generate investment cycles even in an environment where first-best capital stock is constant.

Suggested Citation

  • Mark Aguiar & Manuel Amador & Gita Gopinath, 2006. "Efficient expropriation: sustainable fiscal policy in a small open economy," Working Papers 06-9, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbwp:06-9
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    References listed on IDEAS

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    Cited by:

    1. Acemoglu, Daron & Golosov, Mikhail & Tsyvinski, Aleh, 2011. "Political economy of Ramsey taxation," Journal of Public Economics, Elsevier, vol. 95(7), pages 467-475.
    2. Marina Azzimonti-Renzo & Pierre-Daniel G. Sarte, 2007. "Barriers to foreign direct investment under political instability," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 287-315.
    3. Catarina Reis, 2013. "Taxation without commitment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 52(2), pages 565-588, March.
    4. Ilzetzki, Ethan, 2011. "Rent-seeking distortions and fiscal procyclicality," Journal of Development Economics, Elsevier, vol. 96(1), pages 30-46, September.

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    Keywords

    Fiscal policy;

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