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Borrow and Adjust: Fiscal Policy and Sectoral Adjustment in an Open Economy*
Author(s) -
Steigum Erling,
Thøgersen Øystein
Publication year - 2003
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/1468-2354.t01-1-00086
Subject(s) - economics , fiscal policy , shock (circulatory) , small open economy , monetary economics , welfare , normative , production (economics) , short run , macroeconomics , open economy , social security , monetary policy , exchange rate , market economy , medicine , philosophy , epistemology
Should the government run fiscal deficits in response to an adverse external shock that warrants transfer of resources from production of nontraded to traded goods? This article considers normative fiscal policy implications of sectoral adjustment costs in a two‐sector model with overlapping generations. Fiscal deficits benefit present generations by depleting foreign assets and slowing down the adjustment process. We show that despite no nominal rigidities, temporary fiscal deficits increase social welfare if adjustment costs prevent immediate sectoral reallocation of inputs. If there are no adjustment costs, the case for fiscal deficits vanishes.