Working Paper: NBER ID: w1961
Authors: Alan C. Stockman
Abstract: This paper examines the effects of fiscal policies in an open economy when international financial markets are well developed. Consumers use these markets to hedge against the risk of uncertain future changes in government policies. These portfolio allocations alter the effects of changes in government policies, if and when they occur, as compared to a world with more limited financial markets. Three examples are discussed. The first involves a change in (productive) government spending, financed by a change in lump-sum taxes, in a large open economy with two goods. The second example concerns the effects of temporary changes in distorting taxes. The final example concerns the open-economy effects of changes in government deficits, due to changes in lump-sum taxes, without Ricardian equivalence. In each example the existence of opportunities to trade on well-developed international financial markets is shown to alter, in important ways, the effects of changes in government policies. The empirical significance of these differences should grow as international financial markets continue to develop in breadth and sophistication.
Keywords: Fiscal Policy; International Financial Markets; Consumption Smoothing
JEL Codes: E62; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Changes in productive government spending (H59) | Redistribution of wealth (H23) |
| Redistribution of wealth (H23) | Affects consumption patterns in both domestic and foreign markets (F61) |
| Redistribution of wealth (H23) | Domestic consumption decreases (D12) |
| Redistribution of wealth (H23) | Foreign consumption increases (F69) |
| Risk-averse individuals adjusting savings behavior (D15) | Consumption smoothing (D15) |
| Temporary changes in distorting taxes (H31) | Different implications in the presence of international asset markets (G15) |
| Government deficits (H62) | Increased domestic aggregate demand (E20) |
| Government deficits (H62) | Negatively affecting foreign aggregate demand (F69) |
| Existence of sophisticated international financial markets (G15) | Alters effects of fiscal policies (E62) |