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Savers, Spenders and Fiscal Policy in a Small Open Economy

  • Egil Matsen

    ()

    (Department of Economics, Norwegian University of Science and Technology)

  • Ragnar Torvik

    ()

    (Department of Economics, Norwegian University of Science and Technology)

  • Tommy Sveen

    ()

    (Central Bank of Norway)

This paper analyzes the effects of fiscal policy in an open economy. We extend the savers-spenders theory of Mankiw (2000) to a small open economy with endogenous labor supply. We first show how the Dornbusch (1983) consumption-based real interest rate for open economies is modified when labor supply is endogenous. We then turn to the effects of fiscal policy when there are both savers and spenders. With this heterogeneity taken into account, tax cuts have a short-run contractionary effect on domestic production, and increased public spending has a short-run expansionary effect. Although consistent with recent empirical work, this result contrasts with those of most other theoretical models. Transitory changes in demand have permanent real effects in our model, and we discuss the implications for real exchange-rate dynamics. We also show how "rational" savers may magnify or dampen the responses of "irrational" spenders, and show how this is related to features of the utility functions.

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File URL: http://www.svt.ntnu.no/iso/WP/2004/12Fiscal_dec_04.pdf
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Paper provided by Department of Economics, Norwegian University of Science and Technology in its series Working Paper Series with number 4704.

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Length: 28 pages
Date of creation: 29 Dec 2004
Date of revision:
Handle: RePEc:nst:samfok:4704
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Web page: http://www.svt.ntnu.no/iso/WP/wp.htm
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  1. Roberto Perotti, 2004. "Estimating the effects of fiscal policy in OECD countries," Working Papers 276, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  2. Poterba, James M, 1988. "Are Consumers Forward Looking? Evidence from Fiscal Experiments," American Economic Review, American Economic Association, vol. 78(2), pages 413-18, May.
  3. Jordi Galí & Tommaso Monacelli, 2004. "Monetary policy and exchange rate volatility in a small open economy," Economics Working Papers 835, Department of Economics and Business, Universitat Pompeu Fabra.
  4. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October.
  5. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc.
  6. Jordi Gali & J. David Lopez-Salido & Javier Valles, 2004. "Rule-of-Thumb Consumers and the Design of Interest Rate Rules," NBER Working Papers 10392, National Bureau of Economic Research, Inc.
  7. Jordi Galí & J. David López-Salido & Javier Vallés, 2005. "Understanding the Effects of Government Spending on Consumption," NBER Working Papers 11578, National Bureau of Economic Research, Inc.
  8. Perotti, Roberto, 2002. "Estimating the effects of fiscal policy in OECD countries," Working Paper Series 0168, European Central Bank.
  9. Campbell, John Y & Mankiw, N Gregory, 1990. "Permanent Income, Current Income, and Consumption," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(3), pages 265-79, July.
  10. Dornbusch, Rudiger, 1983. "Real Interest Rates, Home Goods, and Optimal External Borrowing," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 141-53, February.
  11. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
  12. Edward N. Wolff, 1998. "Recent Trends in the Size Distribution of Household Wealth," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 131-150, Summer.
  13. N. Gregory Mankiw, 1999. "The Savers-Spenders Theory of Fiscal Policy," Harvard Institute of Economic Research Working Papers 1888, Harvard - Institute of Economic Research.
  14. Boskin, Michael J, 1988. "Consumption, Saving, and Fiscal Policy," American Economic Review, American Economic Association, vol. 78(2), pages 401-07, May.
  15. repec:fth:harver:1435 is not listed on IDEAS
  16. Torsten Persson, 1983. "Deficits and Intergenerational Welfare in Open Economies," NBER Working Papers 1083, National Bureau of Economic Research, Inc.
  17. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Economics Working Papers 015, European Network of Economic Policy Research Institutes.
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