Can Fiscal Policy Improve Welfare in a Small Dependent Economy with Feedback Effects?

Abstract

I develop an intertemporal general equilibrium two-sector model for a small dependent economy. Firms in the non-tradable-good sector are assumed to be large, both at the industry and the economy levels, and to compete over quantities. The exchange rate is ¢xed and ¢nancial capital is perfectly mobile. I study the e¡ects of government purchases of goods on the macroeconomic short-and long-run equilibria when entry is possible. Su¤cient conditions for welfare improvement are also derived. " IntroductionIn the last decade the analysis of open-economy macroeconomics has shifted from a static framework to an intertemporal one. Simultaneously, macroeconomic models have increasingly incorporated imperfectly competitive structures in order to bypass the limitations of the Walrasian framework. These two features, however, remained separate in international macromodels until the middle of the 1990söas an example see, inter alia, Backus et al. (1994) and Dixon (1994). Even for closed economies, dynamic general equilibrium models with imperfect competition are a recent ¢eld of researchösee inter alia Hairault and Portier (1993) and Rotemberg and Woodford (1995) for some of the earlier references. This paper combines both features following Obstfeld and Rogo¡ (1995). The domestic economy is assumed to be divided in two sectors: one producing a tradable good and the other a non-tradable good. Since the economy is small in the international market for the tradable good, perfect competition holds in its domestic market. As in Dixon (1994), the nontradable-good market is assumed to be imperfectly competitive. However, instead of considering monopolistically competitive markets as in the Dixit and Stiglitz (1977) and Blanchard and Kiyotaki (1987) tradition, size is to the participants at the MMF Conference (Durham), workshops at the universities of Warwick and York, a seminar at ISEG, Technical University of Lisbon, and to two anonymous referees for their comments and suggestions. Faults, of course, remain my own.

Fiscal Policy Under Imperfect Competition: A Survey

“…In this case, we would observe a feedback e¤ect from the macro into the microeconomic level. For a few examples of models that consider the possibility of large …rms at the economy level see Costa (2001), D'Aspremont et al (1989, or Wu and Zhang (2000), amongst other.…”

Non-Smooth Dynamics and Multiple Equilibria in a Cournot-Ramsey Model with Endogenous Markups

“…Entry reduces the market share of firms, and hence reduces the "own price effect" of the monopolist on the aggregate price index, which increases the elasticity of demand (see Yang and Heidra (1993)). Other papers that consider a variety of aggregate feedback mechanisms are or D' Aspremont et al (1989), Wu and Zhang (2000) and Costa (2001).…”

“…Chatterjee et al (1993), D'Aspremont et al (1995), dos Santos Ferreira andLloyd-Braga (2005), or Kaas and Madden (2005)), or discrete-time Real Business Cycle (RBC) models (e.g. dos Santos Ferreira and Dufour (2006) , Portier (1995), Costa (2001) and Costa (2006)). Continuous-time models where Cournot competition is the mechanism generating endogenous markups are not abundant.…”

Entry and fiscal policy effectiveness in a small open economy within a Monetary Union

“…Costa (2001) assumes a single type of labour for a homogeneous non-tradable good model. 2 One can see this as a reduced form for a centralised utilitarian two-individual household where each one is endowed with a specific type of human capital, they share identical preferences and consumption distribution is equalitarian.…”

“…Since empirical evidence suggests this elasticity to be small, and numerical experiments for positive values of γ do not generate significant differences, I use this simplified version. For more details see Costa (2001). c NT j; t j ¼ 1; .…”