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Efficient expropriation: sustainable fiscal policy in a small open economy

Mark Aguiar, Manuel Amador and Gita Gopinath

No 06-9, Working Papers from Federal Reserve Bank of Boston

Abstract: We study a small open economy characterized by two empirically important frictions? incomplete financial markets and an inability of the government to commit to policy. We characterize the best sustainable fiscal policy and show that it can amplify and prolong shocks to output. In particular, even when the government is completely benevolent, the government?s credibility not to expropriate capital varies endogenously with the state of the economy and may be ?scarcest? during recessions. This increased threat of expropriation depresses investment, prolonging downturns. It is the incompleteness of financial markets and the lack of commitment that generate investment cycles even in an environment where first-best capital stock is constant.

Keywords: Fiscal; policy (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-pbe
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