Efficient Expropriation: Sustainable Fiscal Policy in a Small Open Economy

Mark Aguiar, Manuel Amador and Gita Gopinath
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Mark Aguiar: Federal Reserve Bank of Boston

Working Papers from Princeton University. Economics Department.

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 endogenously varies 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 lack of commitment that generate investment cycles even in an environment where first best capital stock is constant.

Keywords: Open Economy; Financial Markets; Fiscal Policy (search for similar items in EconPapers)
JEL-codes: E62 F41 G10 (search for similar items in EconPapers)
Date: 2006-01
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Working Paper: Efficient expropriation: sustainable fiscal policy in a small open economy (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:pri:econom:2006-2

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