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Savers, Spenders and Fiscal Policy in a Small Open Economy

Author

Listed:
  • 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)

Abstract

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.

Suggested Citation

  • Egil Matsen & Ragnar Torvik & Tommy Sveen, 2004. "Savers, Spenders and Fiscal Policy in a Small Open Economy," Working Paper Series 4704, Department of Economics, Norwegian University of Science and Technology.
    • Handle: RePEc:nst:samfok:4704
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    References listed on IDEAS

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    1. Jordi Galí & J. David López-Salido, 2003. "Rule-of-Thumb Consumers and the Design of Interest Rate Rules," Working Papers 104, Barcelona School of Economics.
    2. Perotti, Roberto, 2002. "Estimating the effects of fiscal policy in OECD countries," Working Paper Series 168, European Central Bank.
    3. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246, National Bureau of Economic Research, Inc.
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    6. Jordi Galí & J. David López-Salido & Javier Vallés, 2007. "Understanding the Effects of Government Spending on Consumption," Journal of the European Economic Association, MIT Press, vol. 5(1), pages 227-270, March.
    7. Roberto Perotti, 2005. "Estimating the effects of fiscal policy in OECD countries," Proceedings, Federal Reserve Bank of San Francisco.
    8. N. Gregory Mankiw, 2000. "The Savers-Spenders Theory of Fiscal Policy," American Economic Review, American Economic Association, vol. 90(2), pages 120-125, May.
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    2. Dirk Niepelt & Harris Dellas, 2013. "Credibility For Sale," 2013 Meeting Papers 12, Society for Economic Dynamics.
    3. Dirk Niepelt, 2009. "Sovereign Debt Maturity without Commitment," 2009 Meeting Papers 231, Society for Economic Dynamics.
    4. Harris Dellas & Dirk Niepelt, 2021. "Austerity," The Economic Journal, Royal Economic Society, vol. 131(634), pages 697-712.
    5. Gábor P. Kiss, 2007. "One-off and off-budget items: An alternative approach," MNB Conference Volume, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 1(1), pages 18-27, December.
    6. Heijdra, Ben J. & Ligthart, Jenny E., 2010. "The Transitional Dynamics Of Fiscal Policy In Small Open Economies," Macroeconomic Dynamics, Cambridge University Press, vol. 14(1), pages 1-28, February.
    7. Niepelt, Dirk, 2014. "Debt maturity without commitment," Journal of Monetary Economics, Elsevier, vol. 68(S), pages 37-54.

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    More about this item

    Keywords

    rule-of-thumb consumers; fiscal policy; open economy.;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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