Fiscal Policy in Open, Interdependent Economies

Willem Buiter

No 28, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: The paper studies the effects of alternative financing policies in the open economy. There is a non-trivial role for financing policy because of the failure of first-order debt neutrality due to uncertain private lifetimes. Both the single-country case and the interdependent two-country case are considered. Capital formation is endogenous and there are unified global financial and goods markets determining the interest rate, each country's "Tobin's q" and the terms of trade. The government's present value budget constraint or solvency constraint and the assumption that the interest rate exceeds the growth rate imply that, given spending, current tax cuts imply future tax increases. Such policies boost the outstanding stock of public debt, raise the world interest rate, crowd out capital formation at home and abroad, and lead to a loss of foreign assets. Provided a "supply-side-response-corrected" transfer criterion is satisfied, the terms of trade will improve in the short run and worsen in the long run.

Keywords: Debt Neutrality; Fiscal Policy; Open Economies (search for similar items in EconPapers)
Date: 1984-09
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Citations: View citations in EconPapers (10)

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Related works:
Chapter: Fiscal Policy in Open, Interdependent Economies (1987)
Working Paper: Fiscal policy in open, interdependent economies (1984)
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