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Fiscal Sustainability, Macroeconomic Stability, and Welfare under Fiscal Discipline in a Small Open Economy

  • Keiichi Morimoto


    (Department of Economics, Meisei University)

  • Takeo Hori


    (College of Economics, Aoyama Gakuin University)

  • Noritaka Maebayashi


    (Graduate School of Economics, Osaka University)

  • Koichi Futagami


    (Graduate School of Economics, Osaka University)

We construct a small open economy model of endogenous growth with public capital accumulation and examine how a debt policy rule under which the government gradually reduces its debt-GDP ratio to a target level affects macroeconomic stability, fiscal sustainability, and welfare. We obtain the following implications for fiscal policy design in small countries. First, to ensure fiscal sustainability, the government should adjust public spending rather than the income tax rate to finance public debt. In addition, it has to set the target level of the debt-GDP ratio sufficiently low to avoid expectations-driven economic instabilities. Under sustainability and stability, a tighter (looser) debt rule brings welfare gains when the world interest rate is relatively high (low).

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Paper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 13-07.

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Length: 25 pages
Date of creation: May 2013
Date of revision:
Handle: RePEc:osk:wpaper:1307
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