SAVERS, SPENDERS AND FISCAL POLICY IN A SMALL OPEN ECONOMY
This paper analyzes the effects of fiscal policy in an open economy.
the savers-spenders theory of Mankiw (2000) to a small open economy with
endogenous labor supply. We first show how the Dornbusch (1983) consumption-based
real interest rate for open economies is modified when labor supply is
endogenous. We then turn to the effects of fiscal policy when there are
both savers and spenders. With this heterogeneity taken into account,
tax cuts have a short-run contractionary effect on domestic production,
and increased public spending has a short-run expansionary effect. Although
consistent with recent empirical work, this result contrasts with those
of most other theoretical models. Transitory changes in demand have permanent
real effects in our model, and we discuss the implications for real exchange-rate
dynamics. We also show how "rational" savers may magnify or
dampen the responses of "irrational" spenders, and show how
this is related to features of the utility functions.