The Transitional Dynamics of Fiscal Policy in Small Open Economies

41 Pages Posted: 23 Aug 2006

See all articles by Ben J. Heijdra

Ben J. Heijdra

University of Groningen - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Jenny E. Ligthart

Tilburg University - CentER, Department of Economics; University of Groningen - Faculty of Economics and Business; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: August 2006

Abstract

The paper studies the dynamic macroeconomic effects of fiscal shocks of various duration (permanent and temporary) under different financing methods (lump-sum tax and government debt). To this end, we develop an intertemporal macroeconomic model for a small open economy, featuring monopolistic competition in the intermediate goods market, endogenous (intertemporal) labor supply, and finitely lived households. Endogenous labor supply is crucial in generating cyclical adjustment paths and yields faster convergence to the new steady state compared with exogenous labor supply. The quantitative output effects and transitional dynamics of fiscal policy differ substantially from those of an infinitely lived representative agent model. In addition, government debt is key in making the timing of shocks matter, thus yielding permanent output effects of temporary fiscal shocks.

Keywords: fiscal policy, output multipliers, Blanchard-Yaari overlapping generations, monopolistic competition, small open economy

JEL Classification: E12, E63, L16

Suggested Citation

Heijdra, Ben J. and Ligthart, Jenny E., The Transitional Dynamics of Fiscal Policy in Small Open Economies (August 2006). CESifo Working Paper Series No. 1777. Available at SSRN: https://ssrn.com/abstract=926036

Ben J. Heijdra

University of Groningen - Department of Economics ( email )

P.O. Box 800
9700 AV Groningen
Netherlands
+31 50 363 7303 (Phone)
+31 50 363 7337 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Jenny E. Ligthart (Contact Author)

Tilburg University - CentER, Department of Economics ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 8755 (Phone)
+31 13 466 4032 (Fax)

University of Groningen - Faculty of Economics and Business ( email )

Postbus 72
9700 AB Groningen
Netherlands

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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