The policy (in)effectiveness of government spending in a dependent economy
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This paper analyses the policy effectiveness of government spending in a two-sector open economy whose output and expenditure is comprised of tradables and non-tradables. This framework reveals that government spending on either tradables or, more normally, on non-tradables widens the external deficit, yet how the real exchange rate behaves depends, in the first instance, on in which sector the public spending occurs. It also shows that, irrespective of where government spending falls, there appears to be no significant short run boost to overall output and hence employment a priori, although empirically actual impact would depend on the elasticities of tradable and non-tradable output with respect to the real exchange rate. Furthermore, fiscal stimulus is shown to be unambiguously ineffective if deemed unsustainable by foreign lenders, or implemented under a fixed exchange rate regime with limited capital mobility.
Journal of Economic Policy Reform
© 2013 Routledge, Taylor & Francis. This is an electronic version of an article published in Journal of Economic Policy Reform, Vol. 16(3), 2013, pp. 287-301. Journal of Economic Policy Reform is available online at: http://www.tandfonline.com with the open URL of your article.
Applied Economics not elsewhere classified
Policy and Administration not elsewhere classified