External Shocks and the Process of Fiscal Adjustment in a Small Open Developing Economy

Abstract

Fiscal policy responses to external shocks are analyzed in an institutional setting that typically characterizes a small open developing economy. In such an economy, taxation of external trade is a major source of government revenue, and external shocks have direct impacts on the fiscal sector. The paper discusses the roles of anticipation and policy rules in the fiscal adjustment process. The paper also discusses the implications of two possible policy rules--stabilizing government expenditure and stabilizing the fiscal balance.