Fiscal policy and direct crowding-out in a small open economy |
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Authors: | Juha Tervala |
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Institution: | (1) University of Helsinki and HECER, Helsinki, Finland;(2) Department of Economics, University of Helsinki, P. O. Box 17, Helsinki, 00014, Finland |
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Abstract: | This paper analyses the welfare effects of fiscal policy in a small open economy, where private and government consumption
are substitutes in terms of private utility. The main findings are as follows: fiscal policy raises output, bringing it closer
to its efficient level, but is not welfare-improving even though government spending directly affects private utility. The
main reason for this is that the introduction of useful government spending implies a larger crowding-out effect on private
consumption, when compared with the ‘pure waste’ case. Utility decreases since one unit of government consumption yields less
utility than one unit of private consumption. In any case, the marginal rate of substitution between private and government
consumption is a key parameter in governing the welfare effects of fiscal policy.
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Keywords: | Fiscal policy Direct crowding-out New open economy macroeconomics |
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