Savers, Spenders and Fiscal Policy in a Small Open Economy

33 Pages Posted: 13 Jan 2006

See all articles by Egil Matsen

Egil Matsen

Norwegian University of Science and Technology (NTNU) - Faculty of Social Sciences and Technology Management

Tommy Sveen

Norges Bank - Research Department

Ragnar Torvik

Norwegian University of Science and Technology (NTNU) - Department of Economics

Date Written: December 2005

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.

Keywords: rule-of-thumb consumers, fiscal policy, open economy

JEL Classification: E21, E62, F41

Suggested Citation

Matsen, Egil and Sveen, Tommy and Torvik, Ragnar, Savers, Spenders and Fiscal Policy in a Small Open Economy (December 2005). CESifo Working Paper Series No. 1618. Available at SSRN: https://ssrn.com/abstract=875564

Egil Matsen (Contact Author)

Norwegian University of Science and Technology (NTNU) - Faculty of Social Sciences and Technology Management ( email )

NO-7491 Trondheim
Norway

Tommy Sveen

Norges Bank - Research Department ( email )

P.O. Box 1179
Oslo, N-0107
Norway

Ragnar Torvik

Norwegian University of Science and Technology (NTNU) - Department of Economics ( email )

N-7491 Trondheim
Norway
+47 735 91420 (Phone)
+47 735 96954 (Fax)

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