Optimal Fiscal Policy in a Small Open Economy and the Structure of International Financial Markets

Cortés Espada Josué Fernando

No 2007-07, Working Papers from Banco de México

Abstract: This paper characterizes the behavior of debt and tax rates in a small open economy under both complete and incomplete markets. First, I show that when the government follows an optimal fiscal policy and agents have access to complete markets, the value of the government's debt portfolio is negatively correlated with government spending, and positively correlated with productivity and output, while output, labor, consumption and the tax rate are uncorrelated with government spending shocks. The stochastic processes followed by these variables inherit the serial-correlation properties of the stochastic process of the productivity shock. Second, I show that if agents can only buy and sell one-period risk-free bonds, public debt shows more persistence than other variables, and it is negatively correlated with productivity and output, and positively correlated with government spending. Moreover, the tax rate is positively correlated with government spending, while consumption is negatively correlated.

JEL-codes: E60 F34 F41 G15 H21 (search for similar items in EconPapers)
Date: 2007-03
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:bdm:wpaper:2007-07

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