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Federal Reserve Bank of Boston
Working Papers
Efficient expropriation: sustainable fiscal policy in a small open economy
Mark Aguiar
Manuel Amador
Gita Gopinath
Abstract

We study a small open economy characterized by two empirically important frictions— incomplete financial markets and an inability of the government to commit to policy. We characterize the best sustainable fiscal policy and show that it can amplify and prolong shocks to output. In particular, even when the government is completely benevolent, the government’s credibility not to expropriate capital varies endogenously with the state of the economy and may be “scarcest” during recessions. This increased threat of expropriation depresses investment, prolonging downturns. It is the incompleteness of financial markets and the lack of commitment that generate investment cycles even in an environment where first-best capital stock is constant.


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Mark Aguiar & Manuel Amador & Gita Gopinath, Efficient expropriation: sustainable fiscal policy in a small open economy, Federal Reserve Bank of Boston, Working Papers 06-9, 2006.
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Keywords: Fiscal policy
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