Optimal Government Spending Reversal in a Small Open Economy
This paper reexamines optimal debt stabilization policy in a small open economy borrowing from abroad. We incorporate spending reversals as a policy option available to policy-makers for stabilizing public debt. Results show that spending reversals can be welfare-improving and that there exists an optimal degree of spending reversal if the debt elasticity of the country-specific risk premium is high. The tradeoff between smoothing the tax rate and stabilizing the sovereign interest rate in the discussion of optimal tax rate policy (Bi, 2010) does not arise. Spending reversals can lower both the tax rate volatility and that of the interest rate.
|Date of creation:||Sep 2011|
|Date of revision:||Oct 2012|
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