On the International Dimension of Fiscal Policy

38 Pages Posted: 7 Apr 2009

See all articles by Gianluca Benigno

Gianluca Benigno

London School of Economics & Political Science (LSE) - Department of Economics; Federal Reserve Bank of New York

Bianca De Paoli

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP)

Date Written: March 2009

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

JEL Classification: E62, E63, F41

Suggested Citation

Benigno, Gianluca and De Paoli, Bianca, On the International Dimension of Fiscal Policy (March 2009). CEPR Discussion Paper No. DP7232, Available at SSRN: https://ssrn.com/abstract=1372552

Gianluca Benigno (Contact Author)

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 7807 (Phone)

Federal Reserve Bank of New York ( email )

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New York, NY 10045
United States

Bianca De Paoli

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

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