On the International Dimension of Fiscal Policy

Gianluca Benigno and Bianca De Paoli ()

No 7232, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper analyses the international dimension of fiscal policy using a small open economy framework in which the government finances its spending by levying distortionary taxation and issuing non-state-contingent debt. The main finding of the paper is that, once the open economy aspect of the policy problem is considered, it is not optimal to smooth taxes following idiosyncratic shocks. Even when prices are flexible and inflation can costlessly act as a shock absorber to restore fiscal equilibrium, the presence of a terms of trade externality lead to movements in the tax rate. Also in contrast with the closed economy, the introduction of sticky prices, can reduce the optimal volatility of taxes.

Keywords: Fiscal policy; Optimal policy; Small open economy (search for similar items in EconPapers)
JEL-codes: E62 E63 F41 (search for similar items in EconPapers)
Date: 2009-03
New Economics Papers: this item is included in nep-cba and nep-mac
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Citations: View citations in EconPapers (8)

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Related works:
Journal Article: On the International Dimension of Fiscal Policy (2010)
Working Paper: On the International Dimension of Fiscal Policy (2009)
Working Paper: On the international dimension of fiscal policy (2009)
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