Fiscal policy in classical and Keynesian open economies

Klaus Schmidt-Hebbel and Luis Servén

No 1299, Policy Research Working Paper Series from The World Bank

Abstract: The authors analyze the impact of fiscal policy changes in openeconomies, using a rational expectation framework that nests two prototype economies: a neoclassical full-employment benchmark economy, with intertemporally optimizing consumers and firms and instant clearing of asset, goods, and factor markets; and a Keynesian economy, with liquidity constraints and wage rigidity, which results in transitory deviations from full employment. The model is forward-looking in that the economy's short-run equilibrium depends on current and anticipated future values of all exogenous variables, and displays hysteresis (that is, its long-run equilibrium is path-dependent). Using parameters for a representative open economy, the model is simulated to compare the dynamic effects of increases in public spending financed by taxation, debt, and money. The results illustrate four points. Both permanent and transitory disturbances cause changes in long-run output and capacity. Transitory and permanent shocks may have opposite effects on the current account. Liquidity constraints and wage rigidities tend to amplify the cyclical adjustment to fiscal policy changes. The Keynesian economy's response to fiscal shocks depends critically on the way the budget is financed: money-financed fiscal expansion causes real depreciation; non-money-financed fiscal expansion causes appreciation.

Keywords: Environmental Economics&Policies; Economic Stabilization; Banks&Banking Reform; Macroeconomic Management; Economic Theory&Research (search for similar items in EconPapers)
Date: 1994-05-31
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www-wds.worldbank.org/external/default/WDSC ... d/PDF/multi_page.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wbk:wbrwps:1299

Access Statistics for this paper

More papers in Policy Research Working Paper Series from The World Bank 1818 H Street, N.W., Washington, DC 20433. Contact information at EDIRC.
Bibliographic data for series maintained by Roula I. Yazigi ().