This paper examines the effects of fiscal policies in an open economy when
international financial markets are well developed. Consumers use these
markets to hedge against the risk of uncertain future changes in government
policies. These portfolio allocations alter the effects of changes in
government policies, if and when they occur, as compared to a world with more
limited financial markets. Three examples are discussed. The first involves
a change in (productive) government spending, financed by a change in
lump-sum taxes, in a large open economy with two goods. The second example
concerns the effects of temporary changes in distorting taxes. The final
example concerns the open-economy effects of changes in government deficits,
due to changes in lump-sum taxes, without Ricardian equivalence. In each
example the existence of opportunities to trade on well-developed
international financial markets is shown to alter, in important ways, the
effects of changes in government policies. The empirical significance of
these differences should grow as international financial markets continue to
develop in breadth and sophistication.
*Published: This paper was subsequently published as Fiscal Policies and International Financial Markets, Alan C. Stockman, in NBER book International Aspects of Fiscal Policies (1988)
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