Optimal Fiscal Policy in a Small Open Economy with Incomplete Markets and Interest Rate Shocks

Cortés Espada Josué Fernando

No 2006-09, Working Papers from Banco de México

Abstract: This paper studies optimal fiscal policy in a small open economy model under incomplete financial markets, where interest rates, government spending and productivity are stochastic and taxes are distortionary. The contributions of the paper are twofold. First, I solve the Ramsey problem and characterize the properties of the optimal fiscal policy. Second, I show that the optimal fiscal policy consists in smoothing tax distortions over time. The income tax rate, and the public debt are very persistent irrespective of the degree of autocorrelation of the shocks generating aggregate fluctuations. The government finances an increase in government spending or a decrease in the tax base partly by increasing debt and partly by increasing the tax rate.

JEL-codes: E60 F34 F41 H21 (search for similar items in EconPapers)
Date: 2006-09
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:bdm:wpaper:2006-09

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